risk–reward potential remains approximately the same for all markets and time
periods.
This book is for those traders who haven’t been able to pinpoint what is miss-
ing to make the complete strategy larger than the sum of its parts. If you allow me
to take a guess, I’d guess that what you feel is keeping you from succeeding as a
trader is the overall understanding for how it all ties together and what really con-
stitutes a more “sophisticated” strategy with a higher likelihood for success than
the ones you’re currently using. The way I see it, to simplify things, the develop-
ment process could be divided into a few building blocks:
First, we need to learn what we need to measure to achieve robustness and
reliability. Second, we need to learn to formulate and test the logic for the entry
(and possibly also some sort of filtering technique). Third, we must understand and
test different types of exits. The last point of actual research is to apply and test the
money management according to our risk preferences.
The first part of the book will show you how to measure a system’s per-
formance to make it as forward-looking as possible. By forward-looking we mean
that the likelihood for the future results resembling the historical results should be
as high as possible. To do this, you will need to know the difference between a
good working system and a profitable system and which evaluation parameters to
use to distinguish between the two.
The emphasis will lie on making the system work, on average, equally as
well on a large number of markets and time periods. We also will look at other
common system-testing pitfalls, such as working with bad data and not normaliz-
ing the results. Another important consideration is to understand what constitutes
realistic results and what types of results to strive for. A lot of the analysis work
will be done in TradeStation and MS Excel.
In the second part, we will take a closer look at the systems we will work
with throughout the rest of the book. All eight systems have previously been fea-
tured in Active Tradermagazine’s Systems Trading lab pages. The systems are
selected only as good learning experiences, not for their profitability or trading
results. We will look at the systems one at a time and determine how we can mod-
ify them to make them more robust and forward-looking.
All changes will be based on logic and reasoning, rather than optimization
and curve fitting, and are aimed to improve the system’s average performance over
a large number of markets and time periods, rather than optimizing the profits for
a few select markets. The working premise will be, the better we understand the
logic behind the system and the less complex the system, the more we trust it will
function as well in the future as it has in the past. For this, we will do most of the
work in MS Excel, which means we need to learn how to export the data from our
analysis software of choice.
Usually when I build a system, I don’t count the stop-loss and exit rules to
the core system logic. In Part 3 we therefore substitute all the old exit rules for allxviii IntroductionStridsman FM 5/27/03 4:39 PM Page xviii