This test batch consists of: 25 different tests, on 5 different markets

over a 10-year time span divided into two-year data segments. The moving
average strategy will be simulated with parameters of 5 and 20 days.
The Results of the Test
The results of the 25 different tests are summarized in Tables 8.6, 8.7,
and 8.8.
As stated earlier, the main objective of this test is to determine whether
the trading strategy is worthy of further development. A trading strategy
that produces exceptional results at this stage of testing is certainly one
worthy of further development without reservation. Conversely, a trading
strategy that produces deplorable results is likely to not be worthy of further development. There are exceptions to this, however, and this is preliminary testing. If the strategist has reasons to think it may improve with
further development, then proceed. If not, conclude research on this strategy. Last, if the results are average, further development is also warranted.CHA
PTER 9
Search and
Judgment
he next stage in the evaluation of a trading strategy is optimization,
which is presented in the next chapter. Before we can proceed with
a presentation of these methods, however, we need to explore a little
understood but extremely important aspect of this process: the search of
the optimization space.
To fully understand the most effective way optimization can be applied
to a particular trading strategy, we need to understand the contours of this
seemingly innocuous area. And before we can fully understand how we
can arrive at those trading strategy parameters that are most likely going
to produce real-time and lasting trading profits, we need to understand the
all-important impact of what has typically been known as the optimization
criterion. In optimization theory this is also known as the fitness function, objective function, search criteria, and search function. In conformity with contemporary usage, we will use the term objective function as
synonyms for all of these other terms.
To elaborate, the optimization space is simply the set of all possible
strategy parameters, or candidates, for which a historical simulation can
be created. An optimization must be performed on multiple pairs of different moving average lengths to determine the most profitable combination
of moving averages for our moving average example. To do this, for example, an optimization is set to scan, or create, a simulation for every combination of moving average lengths for MA1 from 2 to 10 at steps of 1 and
for MA2 from 20 to 40 at steps of 2. This optimization will create a total
of 99 different combinations of the two moving average lengths. This is all
explained in more detail later in this chapter.
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THE EVALUATION AND OPTIMIZATION OF TRADING STRATEGIES
After all of these historical simulations have been created, however,
the best parameter combination must still be selected. The objective function is the principle used during the optimization process in making this
selection.
The objective function can be simple or complex. Regardless of complexity, however, the objective function is that algorithm that the optimization process employs to rank and to ultimately select the best combination
of parameters for the trading strategy. The search function, then, is judge
and jury for the trading strategy.
For example, if net profit is our objective function (which by the way, is
not recommended, but since it is widely used and understood, it is helpful
as an example), then that strategy parameter pair that produced the largest
net profit will be selected as best.
Understanding the impact of the search method and of the objective

function are more esoteric and less understood dimensions of the testing
and optimization process. They appear dry and mundane. Yet their impact
on testing and on the understanding of the results is extremely significant.
It is important to keep in mind that the field and literature of optimization theory is extensive and rapidly growing. The current state of the optimization art in contemporary trading strategy development applications
is, to a large degree, actually quite primitive when contrasted to recent developments in optimization theory. Most applications still use brute force
grid search methods coupled with outdated and inefficient search functions such as net profit.
There are add-ins that provide some advanced functionality in this area
such as genetic optimization and Walk-Forward Analysis; 1 there is promise
of more to come.
It is important, however, that the strategist understand that these resources exist and can be brought to bear on a development project. It is
also important to understand that these various advanced search proce-