Forex Trading Systems: Know What Curve Fitting Is Or Lose

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When choosing a FOREX trading system or back testing your own, you need to be aware of the dangers of curve fitting.

While curve fitted FOREX trading systems can look good in theory, in practice they rarely work, lets look at why.

Trading In The Past For Profit

When you see most FOREX trading systems you will see a hypothetical track record. A hypothetical track record is exactly as it sounds - one that has been constructed in hindsight, knowing the closing prices.

You never see a hypothetical track record that makes losses!

However, when you try and trade the system for real you do and this is generally because the track record has been subject to curve fitting.

Curve Fitting

Curve fitting, simply involves tweaking the parameters or rules of the FOREX Trading system to make it profitable.

One trader I know once likened this to shooting at a barn door and then drawing bull?s eyes around everyone afterwards!

Curve fitted systems normally collapse in the brutal world of trading.

There generally easy to spot:

Look for lots pf parameters or rules and different rules, for trading different currencies.

Generally, a technical system that is successful will have the same rules and parameters for ALL currencies traded and there will only be a FEW indicators used.

I once knew a trader who made a million dollars using just one rule and trading around 50 commodities and currencies.

By tweaking the parameter for each contract traded, he could have made it make more money in theory, but that of course means the system would be less robust in real trading, so he stuck with the best parameter that gave the greatest performance over all the contracts traded.

His real track record closely matched his back testing and that?s what you need when you have no real trading to look at.

The Dangers Of Trusting a Hypothetical Track Record

There are many dangers of using hypothetical track records of which curve fitting is just one.

The Impact Of Slippage and Commission

In most instances not shown correctly and hypothetical track records tend to underestimate their impact dramatically.

Most vendors rely on hypothetical track records and you can find some good systems, but you?re always best off to go with a FOREX trading system the vendor has traded himself and made money with.

While it doesn?t guarantee that you will make money from the system, at least the vendor has confidence in it and traded it.

Ask Yourself This Question

Why would you buy a system from someone who says it?s a fantastic way to make money and then hasn?t got the confidence to trade it themselves?

In my time trading (and that?s 22 years) about 90% of the systems I have seen with hypothetical track records, could not stand up to the brutal real world of trading in real time and in the case of day trading systems, its 100%

Independent Verification

You can find some hypothetical track records that are tracked in real time by independent ratings agencies.

If you have one of these, then at least you know that it?s being independently monitored in real time, even though no money is traded.

In conclusion

It’s easy to bend a system to fit the data looking backwards, but making it work going forwards without being able to bend the data is quite another matter.

If you do buy a FOREX trading system with a hypothetical track record, make sure its tracked in real time, look at the logic of the system and look for curve fitting.

If you can though the best way to get the odds on your side with a trading system is to find a vendor who has a real track record and had the confidence to trade their system.

By: Sacha Tarkovsky

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