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10. Conclusion.

Over the course of this article we have developed a trading system for the mini-Dow Jones futures contract using data from January 2004 to June 2004. Starting with a basic idea for trading an open range breakout we have tested and added each component of the system in a methodical manner. It is important to realise that our system has been created using specific data and is optimised for that particular data set. If we have ‘over optimised’ then we will find that when we test using other periods the system will fall apart. Signs of an over optimised system are:

• Lots of different parameters
  
• Very specific values for the parameters. i.e. a value of 47 makes a profit but 46 or 48 don’t.
  
• Different parameter values for different markets or even periods
  
• Using fixed values – i.e. a fixed 35 point stop no matter what the current market volatility.
  
• The system makes a spectacular profit over the testing period and a spectacular loss the rest of the time!

Let’s recap our system to make sure it doesn’t look too optimised:

Market:	Mini Dow Jones $5 futures contract
Set-up:	Trading Range 9.30am – 11.45am ET
Entry:	Long on a break of the high, short on a break of the low of the opening range.
Stop Loss:	The opposite entry point.
Exit:	Stop hit or 16.00 ET.
Other rules:	Do not trade on Thursday.
	Do not trade if previous day’s average trading range > average previous 5 days.

Our set-up contains a specific value for the opening range – 135 minutes. However we tested around this value and anything between 45 minutes and 180 minutes made very little difference overall.

Not trading on Thursday is a very specific rule and could be optimised for our test dataset.

Out of Sample Data

The final test for the system is to check the performance on out of sample data. Here are the results by month after allowing 3 points for slippage and commission.

Quarter	Net Points	Trades	Per Trade
Jan – Mar 2003	393	39	10.08
Apr – Jun 2003	210	36	5.83
Jul – Sep 2003	387	38	10.18
Oct – Dec 2003	214	41	5.22
Jan – Mar 2004	416	42	9.90
Apr – Jun 2004	359	35	10.26
Jul – Sep 2004	60	43	1.40
Oct – Dec 2004	215	37	5.81

As expected our sample period of Jan – Jun 2004 does produce good results, however we also experience similar results for the 1st and 3rd quarters of 2003 suggesting that the system is not over optimised for one particular period.

Draw down

During our test period we experienced a maximum draw down of 181 points, this is exceeded 4 times during our larger back test:

Date	Points
19 Feb 03	234
10 Jun 03	254
19 Aug 03	215
27 Sep 04	189

These are all acceptable as in our money management section we allowed for 2 x 181 points or 362 points for maximum draw down.

Equity Curve

Finally, a quick look at the equity curve for trading a single contract below shows that the system is fairly consistent over the entire period:

Money Management

Trading a single contract makes 2,254 points profit ($11,270) over the 2 year period. Earlier we established a fixed ratio money management model based on our test data. Using this model to trade the system over the 2 year period, turns a starting balance of $4,000 into $47,785, a profit of $43,785. In this case the equity curves looks like:

Finally

In this article we have examined stage by stage the development of a single trading system using as an example the mini-Dow Jones futures contract. We have produced a system which is consistent and which over the past 2 years would have produced a reasonable profit, especially if aggressive money management is used.

It should be noted that over these 2 years the Dow Jones index has experienced very low volatility when compared to previous years making it a fairly difficult time for day trading systems. However, the currency markets have been volatile over this period and we could have chosen to develop a system to trade dollar/euro or dollar/pound futures, which would have been far more profitable. The point of the article was to demonstrate a systematic approach to system development using an instrument that people are familiar with.

Reliance should not be placed a one system alone. A number of different systems should be developed (using the above methodology) using different instruments, timeframes and set-ups (both trend following and counter-trend). In the last year currencies have been more volatile than indexes whereas in 2002 the opposite was true. All systems have good periods and bad periods and by diversifying the systems traded we can substantially reduce the overall draw downs and produce much smoother equity curves.