Ultimate Algorithmic Trading System

This is just one possible solution. You can keep propagating and create a whole
slew of solutions, which is what we are after when we use genetic optimization on
trading algorithms.
Go through the steps until you understand the processes involved. Each step
is logical and nonmath intensive and should give you confidence to utilize this
technology in your own research. Even if you don’t utilize it in research you
can impress your friends at your next cocktail party by explaining what a genetic
algorithm is and the impact of a higher mutation rate on subsequent generations.
■ Using Genetic Algorithms in Trading System
Development
‘‘The same principles which at first view lead to skepticism, pursued to a certain
point, bring men back to common sense.’’
George Berkely
Now armed with a little knowledge the veil of skepticism can be pulled back. This
knowledge can now be applied to a real-life trading problem. Earlier in this chapter,
a trading algorithm was mentioned that consisted of five optimizable parameters.
The system (TA1) utilizes an indicator to determine the market condition so it
can either apply a trend-following or choppy-market algorithm. The switch that
determines condition measures the actual distance a market travels versus the entire
distance a market travels over a certain time period. Imagine a subdivision with a
lot of cul-de-sacs. If you leave your house and go in and out of each cul-de-sac prior
to exiting the subdivision, you will have traveled a long route to go a very short
distance. This indicator is based on momentum and has been around for years. It is
known as the Choppy Market Indicator (CMI). Here is the formula to the indicator:
CMI = (ABS(close(xBars)−close))∕(highest(high, xBars)−lowest(low, xBars))
If the difference between the today’s close and the close xBars back is small and
the highest high and lowest low xBars back is large, then the CMI will be a small
value (Numerator small / Denominator large). A low CMI indicates the market has
traveled a relatively large distance but hasn’t gone anywhere. In other words, the
market is chopping around with no evidence of a trend.
There are two ways we can approach a choppy market condition: We can
(1) avoid it; or (2) implement a swing trading algorithm. TA1 attempts the latter
by using volatility breakout from the prior day’s close as an entry point. If the CMI
is less than xLevel, then long entries are placed at today’s close plus xPercent times
xAR (Exponential Average Range) of the past 20 days. The sellshort signal uses the
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GENETIC OPTIMIZATION, WALK FORWARD
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