V.7:11 (418-421): Optimal parameter selection by Kent Calhoun

V.7:11 (418-421): Optimal parameter selection by Kent Calhoun
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Optimal parameter selection by Kent Calhoun

The success or failure of any trading system hinges on the choice of its parameters. General wisdom holds that optimal parameters are variables that produce the highest cumulative profits on completed trades. My approach is based on a basic defensive trading philosophy—controlling losses is essential to making profits. So, rather than selecting optimal parameters to produce the largest closed cumulative profits, my goal is to locate profitable trading parameters that minimize equity drawdown as the market changes.

Optimal commodity parameters vary from year to year due to the inherently volatile nature of individual commodities. The change of optimal parameters from one time period to the next is called optimal parameter shift. The very best commodity trading systems can have parameter shifts of up to 50% and still be profitable for individual commodities.

For example, imagine the optimal parameters for an eight-year T-bond database produce $40,000 closed cumulative profits annually. In the ninth year, the optimal parameters shift by 50%, yet still produce $30,000 cumulative profit on all closed trades—an excellent system because the equity falloff was 25% even though the parameters shifted 50%.

The goal is to isolate an optimal parameter that is so profitable that shifts of 25% or more will not result in an annual loss for any commodity.

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