Optimal Trading Rules Without Backtesting
29 Pages Posted: 29 Sep 2014 Last revised: 5 Jul 2015
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: Suggested Citation