Curve Fit Traps
"Professional traders know you should
be wary of spikes in your historical data."
When professional traders evaluate systems they use historical price data.
Every system performs differently in the markets and it is essential to
discover its characteristics before you even consider trading it. You must know whether it is capable of operating within your risk limit and if it can achieve the required return.
Any price spikes hidden in the data will distort the results and so it is essential that these are treated with caution.
You are seeking the truest possible guide to the capabilities of the system and whether a spike 'improves' or worsens results, it is equally undesirable.
Spikes are sudden movements (which are unlikely to persist or recur) that produce exceptional price values. They are caused by unexpected events - frequently of a political nature. Therefore, it does not make sense to base any trading conclusions on results containing spikes.
Unsuspecting beginners can get caught by using results that have been tainted by price spikes but professional traders are very wary of the dangers they pose.
Also, in trying to improve system performance, unwary traders can be lured into what are known as 'curve fit traps' which are created by the presence of price spikes.
If the trader's system encounters a data spike, outstanding results may be produced. However, as they arise from exceptional freak price movements, any results will be useless. However, human greed can tempt a trader to believe the incredible.
The evaluation methods used by professional traders ensure that data spikes are avoided. Newcomers to trading should be on their guard against price spikes and learn how to guard against being caught by them.
Copyright David Bromley 2006
All Rights Reserved.