A few fundamental questions about modeling

Discussion in 'Automated Trading' started by chawwal, Aug 9, 2010.

  1. chawwal


    First post here, so be gentle. :)

    I am trying to create my own automated trading system. I'd like to bounce some ideas with you guys, if possible.

    A few questions that came to my mind while implementing this (and my answers):

    1. How frequent should the system try to trade? I chose once or twice per month since I have 0 experience with this stuff. Basically I want a system to predict the price so I can execute trades myself in a semi-automated way.

    2. What should the system predict? I chose to try to predict exact price instead of arrows (whether it will go up or down or flat).

    3. What should it trade? For now, just one high-volume security.

    4. What should it use to "train" or "learn"? I chose a random period in daily price action of a security.

    5. How to measure success of the prediction (when used in training/validation)? I used sum-of-absolute differences.

    Attached is a figure that shows my results. Blue is the actual price. Red is the price this system predicted 25 days in advance.

    Notice how the red price closely follows the blue price for an interval in the middle. That was actually used to train the system.

    It performs rather poorly in the other regions (where I actually want it to succeed, since those are the regions where it will actually execute trades).

    I want to know what the "experts" around here think of how I answered the above questions. Also, if you do design/build systems to predict exact price action, how much is it usually off by?

    I guess if it is not off by much, you would be a billionaire sitting on a yacht right now and wouldn't be bothered to read this forum...

    I'd like to know how accurately people can predict price action if they do use it. I know some people predict direction, not price.
  2. chawwal


    Here is the chart.

    Blue=actual, red=predicted.

    Notice the curve fitting in the middle region that was used to train the system.

    Comments? Too much curve fitting?
  3. januson


    You should break your post up into smaller and more manageable pieces :), posting one question at a time and thoroughly read and reply :)
  4. Your questions are not fundamental.

    It sounds like your are confusing the difference between modeling market action and trading on the predicted results of the model.


    Modeling a trading system and back testing against actual market data.

    Which is it?
  5. januson


    No it's not :D

    Besides that.. if you are asking yourself such questions as "too much curvefitting", then YES! You are curvefitting, a good advice on the road.. avoid curvefitting, optimization etc. The more lagging indicators you are using, the more curvefitting is involved and the more illusions you have regarding the holy path to wealth.

    You are being tricked.... :eek:
  7. 1. Good luck but keep in mind that it will take some time.

    2. You can try to predict exact price although "prediction" is a world used by astrologers and card readers these days. A better world is "forecast" but most traders do not like that either. Most traders neither try to predict nor to forecast. They use probabilities. This is because the market is not a deterministic system. It is highly stochastic, with high unpredictability.

    3. Better to start with mini futures contracts. Stocks sound easy but there are many caveats.

    4. Are you using a NN?

    5. In this methods, small deviations are penalized as much as large deviations. I would use squared deviations.