From the August 01, 2009 issue of Futures Magazine • Subscribe!

Fifteen years and counting

ADAPTIVE SYSTEMS

One particularly innovative approach we published was the concept of the adaptive channel breakout, which first appeared in the January 1996 issue. The goal of this approach was to change the channel length for a channel breakout trading strategy over time depending on shifts in key statistics.

One advance over the years used cycle calculations and smoothing. This technology originally relied on maximum entropy spectra analysis to find the cycles. This algorithm is similar to the concepts used in John Ehlers’ MESA. Ehlers published the Hilbert transform, which calculates the dominant cycle and produces a smooth cycle curve, in 1999. Hilbert limits many of the technical parameters involved in the MEM algorithm, but it does allow this technology to be used by non-engineering types, which means more traders can use this concept.

While adaptive components are potentially very powerful, they don’t work so cleanly with some trading systems. In this case, we want to use walk-forward analysis. Walk-forward testing optimizes a system’s parameters on a given window (say, 1,000 bars). It then runs the system for the next 250 bars, for example. The oldest 250 bars will be dropped off and the system will be re-optimized on this new 1,000-bar window, and so on.

Walk-forward testing works well, but one issue is how you select the best set of parameters and how you deal with two similar sets of parameters based on performance that don’t produce similar trades. Judging how robust the parameters are when they are always changing also is a challenge for walk-forward designs.

A new area of research in this area involves optimizing markets in a portfolio independently and analyzing the optimization surface in N dimensions. N is the number of parameters, plus a performance one. This algorithm also looks at past windows and only changes parameters when a new top set has been developed, not just a new set of parameters that performs better but not significantly so.

For a trading system developer, the best outgrowth of publishing your work is it always pushes you to expand. Sometimes you force yourself into a new topic — writers in all fields almost certainly experience this — but rarely do you come away from these excursions with regret. For those who heed the call, this can be the most rewarding piece of the analytical puzzle.

Murray A. Ruggiero Jr. is a consultant. His firm, Ruggiero Associates, develops market timing systems. He is the author of "Cybernetic Trading Strategies" (Wiley). E-mail him at ruggieroassoc@aol.com.

About the Author
Murray A. Ruggiero Jr.

Murray A. Ruggiero Jr. is the author of "Cybernetic Trading Strategies" (Wiley). E-mail him at ruggieroassoc@aol.com.

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