The 7-Step Process to Develop Professional Algorithmic Trading Strategies

Developing successful trading models requires a systematic approach that combines creativity, technical expertise, and rigorous testing. In this article, we will outline the six essential steps to develop effective trading models. Whether you are a seasoned trader or just starting out, these steps will provide you with a solid foundation for building profitable trading strategies.

1. Trading model selection

The first step in developing successful algorithmic trading strategies is to brainstorm trading models. Trading models are buy-sell engines with specific rules on when to enter, when to exit, and with which position sizing engineering. During the brainstorming phase, it is crucial to think outside the box and explore unique trading ideas not employed by the masses and aligned with your trading goals and risk tolerance. A strong foundation on technical analysis is essential to pass this phase sucessfully.

2. Backtests and KPIs measurement (without overfitting)

Once you have a list of potential trading models, the next step is to backtest this model with different datasets, financial instruments, and underlyings. Unless you are working in a hedge fund that has built its own proprietary trading platform, you do the backtest in third-party trading platforms such as Pro Real Time, Tradestation, Amibroker, or Metaquotes. Even if it is important to backtest the buy-sell engine using historical data to ensure its effectiveness and profitability, this does not guarantee future results. It is crucial to maintain the trading model and risk management simple to avoid overfitting.

3. Walk Forward Optimizations

After developing the initial backtest, it is crucial to perform walk forward optimizations. This involves testing the trading model on out-of-sample data to validate its performance. Walk Forward Optimizations help to identify any overfitting or data snooping biases in the trading model. By dividing the data into multiple segments and testing the model on each segment, you can ensure that the trading model performs well in different market conditions. You can do Walk Forward Optimizations with softwares such as Strategy Quant, Robert Pardo softwares (LDR, Cross, Ranger), or Neuro Shell, among many others.

4. Robustness Tests

Robustness tests are essential to determine the stability and reliability of the trading model. These tests involve subjecting the model to various scenarios and stress tests to evaluate its performance under different market conditions. Robustness tests help to identify any weaknesses or vulnerabilities in the trading model and allow for necessary adjustments and improvements.

5. Monte Carlo Simulations

Monte Carlo simulations are a powerful tool for assessing the risk and potential profitability of a trading model. These simulations involve running multiple iterations of the model using random variations of market data to generate a range of possible outcomes. Monte Carlo simulations help traders understand the probability of different trading outcomes and make informed decisions based on risk-reward analysis.

6. Demo Accounts with Different Position Sizings

Before deploying a trading model with real money, it is recommended to test it on demo accounts with different position sizings. This allows traders to evaluate the performance of the model under different risk levels and position sizes. Demo accounts provide a risk-free environment to fine-tune the trading model and gain confidence in its effectiveness.

7. Real Money and Constant Monitoring

Once the trading model has been thoroughly tested and optimized, it is time to deploy it with real money. However, it is important to remember that trading is an ongoing process that requires constant monitoring and adaptation. Traders should regularly review the performance of their trading model, make necessary adjustments based on market conditions, and continuously improve their trading strategies.

In conclusion, developing successful trading models requires a systematic and disciplined approach. By following the six steps outlined in this article, traders can build robust and profitable trading strategies. Remember to stay updated with market trends, perform thorough testing and optimization, and continuously monitor and adapt your trading model for long-term success.

Francisco F. De Troya

Algorithmic trading & derivatives professional.

Executive Chairman, Blockmas

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