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A Guide to Creating A Successful Algorithmic Trading Strategy by Perry J. Kaufman

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CHAPTER 8 Searching for the Perfect System

What is a perfect system and how do you find it? I don’t think you’ll find two people who agree on that, unless there is a strategy that has only profits and no losses. It’s not likely you’re going to find that one.

Many years ago, when we were having a good run of performance, lots of profits and a few reasonable, not scary, losses, one of our clients called and explained very seriously that he would be willing to give up some of the profits if we could eliminate all of the losses. A nice thought, but as we say, “Not clear on the concept.”

Every trader has a different tolerance for risk and each needs to find a method that minimizes his or her anxiety. I think the anxiety is more important than the potential gain. You’ll never realize the gain if you can’t stay with the program.

Let’s be realistic. Finding the best system involves back- testing. If you’re an algorithmic trader, you can program and test the exact rules. If you’re a systematic trader (discretionary but with clear rules in mind), then you look for past scenarios to confirm your method. It’s not scientific, but it may be the best you can do.

The purpose is clearly to confirm your idea, and the best way is to see how it did in the past. If it flopped badly, why would you trade it? Working in the past doesn’t mean that it will work in the future, but at least it needs to validate your idea of past price action.

Let’s summarize what we’ve discussed in the previous sections: ...

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