Frequently Asked Questions

Dr K Market Direction Model
You place importance on back testing. What in your opinion is the proper way to back test a trading idea?

The most important rule in developing a trading strategy: Do not make postdictive errors by overfitting the curve, then your system predicts the past but not the future.

Backtesting is necessary but:
1) Make sure you test in completely different eras to insure your system is robust.
2) Understand why the worst drawdowns occurred in your system. See you can fine-tune without overfitting the curve.

A good strategy must have inherent logic behind it.

Understand that markets are fluid and subject to inherent change so in exercising your strategy, always understand why its misfiring. If it is just a temporary aberration in the market, then no fine-tuning is necessary. Some make the mistake of fine-tuning when it is unnecessary, such that when conditions return to normal, their trading strategy no longer works as well as it did.

The markets of 2011-2012 have been unpredecented in terms of trendless, gap-up, gap-down volatility, thus long standing market veterans with top trading records have been collectively down in both years, an unprecedented occurrence:

That said, Market Direction Model well outperformed the major averages in 2011 and while 2012 is the toughest year in the long history of the model, new trends begin when least expected. Because I understand this intellectually and emotionally, it allows me to take the bumps and bruises along the way without abandoning my model.

What does not kill us can serve as excellent evolutionary opportunities as traders. 

Published: Nov 15 2012, Modified: Oct 3 2014