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Automation, Diversification, and the “Wrong Way” Approach to Forex Trading
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TRADING SYSTEMS
The Seven Deadly Sins of Automated Trading
In my last article published in FX Trader Magazine “Revolutionize the way you trade”, I covered some thoughts on the FX industry as a good investment and what we look for. As part of that I mentioned the seven deadly sins of strategy development and so I thought it would be a good subject to expand on and provide you with the laws we abide by.
1. Don’t rely on back tests – what you need are out of sample forward tests
My team and I can easily generate a system that uses 1:1 leverage and returns 100% per month in a back test with almost no draw down. I can also guarantee that if we ever turned that system on it would at best remain flat in its performance.
The reason for this is curve-fitting and focusing far too much on the reliance of back tests. The reality is back tests mean nothing in this industry and you should take them merely with a very light pinch of salt.
What we insist on for all systems are out of sample forward tests. This means all decisions are made using the historic information, and only performance generated by data not used within the historic information is considered a true representation of performance.
A lot of systems out there rely too much on back test information and present that as if it were the real system when in fact it is meaningless.
2. Avoid using too small a time horizon
Linked to the point above in the general theme of don’t curve fit systems comes the time horizon question.
This is a little more complex but you need to consider how long a forward test you have to ensure the system works.