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# Method of checking if a trading system "is broken"

Discussion in 'Automated Trading' started by albertly, Oct 23, 2011.

1. ### albertly

I've found very interesting method of checking if a trading system "is broken".
From the book of John Wolberg "Expert Trading System - Modeling Financial Markets with Kernel Regression" page 181â183. One of the most serious book on system design.
(See attachment with links to relevant pages)

I tried to implement his method, but faced with some uncertainties (Bearing in mind that my knowledge of statistics is not good as I would wish)

First of all the author gives us
daily ratio of &#963;/&#956; = 10 (Sigma/Mu = 10)

My first question is where he gets it and what is statistical meaning of dividing standard deviation by mean?

No matter, I can calculate stdev and mean from my equity curve.
1. I get difference of previous day equity and current day equity.
2. Calculate StDev and Average of it.

My second question if is it correct ?

The author still needs to find &#963; and &#956;, but I think it is not the same &#963; and &#956; as above because he calculates
it trade days per year basis i.e. &#956;' = annual profit ^ (-250) - 1 . (daily &#956;')

So I calculate &#956;' . After that I calculate daily &#963;' as 10 * &#956;'

From his formula we can conclude that the less exponent in Eq. (2.13) the better result.
Very logical - the less standard deviation and bigger average change in equity the better.

However if I earn money with the system my equity get bigger and and consequently profit and drawdown is bigger.
It increases StDev.
And look at the formula 2&#956;/&#963;^2 -- Stdev in power of 2.
It means the more money we make, the chance of drawdown grows aprox. in power of 2 and not linear.

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2. ### braincell

That's true in simplistic mathematical models but in practice you will find quite a few ways to counter that and make the ^2 go away. Also very logical, since like in most of math - the basic principles that describe systems in physics have exceptions at extreme values. Such books are interesting reading but they don't contribute much to the practical development of systems unless you need to shape and form your own ideas and put them into similar formulas for easier understanding, which depends on the way you like approaching problems aka how your brain works.

3. ### albertly

The key point is [X(i) - X(i-1)]/X[i-1],
and not what I did [X(i) - X(i-1)] .

Now everything is pretty clear.

4. ### Term

Thanks Albert - I appreciate you following up with that response.

In an attempt to hijack this thread a little bit, does anyone have any tests to check to see if a system is broken that they'd like to share?

I've been reading through a few books on the subject and the ones that I've found so far are:

- Runs Test
- T-Test
- Edge Test (from Acrary)

There are many more than that but does any have one that they've found particular useful?

5. ### albertly

Monte Carlo, of course.

If it is good for nuke, it is also good for trade

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