Mechanical Trading Systems: Pairing Trader Psychology with Technical Analysis

OPTIMIZATION PROCESS

An Overview

Optimization is the process of tweaking the raw trading system by adjusting its parameters (or variables—e.g., number of days, indicator-driven triggers such as moving averages, price-driven triggers such as channel breakout, etc.) and/or parameter sets (or combination of parameter values—e.g., a two moving average crossover system utilizing 9- and 26-day moving averages).⁴ Optimization is a valuable aspect of the system development process because, without this essential step, we would be forced simply to accept whatever performance results were generated by our system's default parameters and parameter sets. Without optimization we might falsely believe a successful system to be unprofitable or, worse still, that a losing system is profitable.

Despite these undeniable benefits, optimization is not without its drawbacks. Modification of parameters and/or parameters sets can easily lead to false expectations regarding the future performance of a system. As with most tools, optimization has its utility, but this utility can be actualized only if the process is employed with diligence toward the scientific process and an awareness of its inherent limitations.

Optimization: Benefits

In addition to the benefits just outlined, optimization enables system developers to test out broad theoretical concepts regarding market behavior (e.g., the market's propensity to trend, to revert to the mean following a parabolic directional move, etc.) prior to commitment ...