EXPERTISE

Trading system design framework and processes

In the financial market, extensive research is conducted to develop sophisticated mathematical trading models. Equally important, if not more, is the framework of implementation – the design of the production system surrounding the existing financial research/models. The design and processes is the linkage of best practices in engineering disciplines and quantitative finance.

In today’s trading world, “the key determinant of sustainable competitive advantage is the ability to continually discover, build, and operate better trading systems” (Andrew Kumiega and Benjamin Van Vliet, 2008). We believe that converting an investment idea into mathematical models and then a working trading system in a fast and high quality manner is critical for one to compete in the market place.

 Backtesting and optimization strategies

Among all the components, backtesting and optimization without overfitting are the most important parts in building a trading system. Often misunderstood and misused, backtest and optimization with right strategies to avoid overfitting in the processes are the keys to building a successful trading system. Many trading systems backed by great investment ideas are abandoned during the backtesting phase as they were not tested properly. Other strategies/models with good backtesting performance failed miserably in live trading and caused a huge capital loss because they were improperly optimized.

Many financial engineers argue that backtesting and optimization are more important than the mathematical and financial theories behind the trading strategies when building high frequency trading systems. You can build a good trading system with a very simple and straightforward model if backtested well and optimized to control risks properly. With inappropriate testing and optimization, trader can convert even a good trading model into a capital disaster.

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