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Determining Optimal Trading Rules without Backtesting

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  • Peter P. Carr
  • Marcos Lopez de Prado

Abstract

Calibrating a trading rule using a historical simulation (also called backtest) contributes to backtest overfitting, which in turn leads to underperformance. In this paper 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.

Suggested Citation

  • Peter P. Carr & Marcos Lopez de Prado, 2014. "Determining Optimal Trading Rules without Backtesting," Papers 1408.1159, arXiv.org, revised Sep 2014.
    • Handle: RePEc:arx:papers:1408.1159
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    File URL: http://arxiv.org/pdf/1408.1159
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    Cited by:

    1. Robert Low & Stanislaus Maier-Paape & Andreas Platen, 2015. "Correctness of Backtest Engines," Papers 1509.08248, arXiv.org.
    2. Stanislaus Maier-Paape & Andreas Platen, 2014. "Backtest of Trading Systems on Candle Charts," Papers 1412.5558, arXiv.org.

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