When a trading strategy has demonstrated that it benefits from optimization, the next step then is to take the strategy through the last and definitive stage in the development process: the Walk-Forward Analysis. The Walk-Forward Analysis judges the performance of a trading system exclusively on the basis of postoptimization or out-of-sample trading.
The performance of a trading strategy on data which were never part of the optimization process is a far more reliable measure than performance based solely on in-sample simulation.
If a trading strategy performs well under a Walk-Forward Analysis, it has shown itself to be robust and capable of producing real-time trading profit. In addition, Walk-Forward Analysis is the closest possible simulation of the way in which an optimizable trading strategy is typically used in real time.
Walk-Forward Analysis provides answers to four essential questions that are necessary to begin and to continue trading a strategy with intelligence and confidence:
1. Is the trading strategy robust? Will it make money in real-time trading?
2. What rate of return will the trading strategy produce in real-time trading?
3. How will the typical changes in market behavior such as trend, volatility and liquidity affect trading performance?
4. What are the best parameters to use in real-time trading to produce maximum profit with minimum risk?
Of course, it is rather obvious that the most important question answered by WFA is the first: ...