Optimal Trading Rules Without Backtesting

29 Pages Posted: 29 Sep 2014 Last revised: 5 Jul 2015

See all articles by Marcos Lopez de Prado

Marcos Lopez de Prado

Cornell University - Operations Research & Industrial Engineering; Abu Dhabi Investment Authority; True Positive Technologies

Date Written: September 28, 2014


Calibrating a trading rule using a historical simulation (also called backtest) contributes to backtest overfitting, which in turn leads to underperformance. We propose a procedure for determining the optimal trading rule (OTR) without running alternative model configurations through a backtest engine. We present empirical evidence of the existence of such optimal solutions for the case of prices following a discrete Ornstein-Uhlenbeck process, and show how they can be computed numerically. Although we do not derive a closed-form solution for the calculation of OTRs, we conjecture its existence on the basis of the empirical evidence presented.

Keywords: Trading rule, backtest overfitting, profit-taking, stop-loss

JEL Classification: G0, G1, G2, G15, G24, E44

Suggested Citation

López de Prado, Marcos and López de Prado, Marcos, Optimal Trading Rules Without Backtesting (September 28, 2014). Available at SSRN: https://ssrn.com/abstract=2502613 or http://dx.doi.org/10.2139/ssrn.2502613

Marcos López de Prado (Contact Author)

Cornell University - Operations Research & Industrial Engineering ( email )

237 Rhodes Hall
Ithaca, NY 14853
United States

HOME PAGE: http://www.orie.cornell.edu

Abu Dhabi Investment Authority ( email )

211 Corniche Road
Abu Dhabi, Abu Dhabi PO Box3600
United Arab Emirates

HOME PAGE: http://www.adia.ae

True Positive Technologies ( email )

United States

HOME PAGE: http://www.truepositive.com

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