The Most Important Guide for All
Traders in 2024
An In-Depth Guide On
Mathematically Improving Your
Trading Strategy
The Most Important Guide for
All Traders in 2024
The Category 3 Trader,
generated by DALL-E
I used to be a Category 1
trader. You see, in this
world, there are 3 types of
traders. Category 1 is
The Uninformed Investor, or
the WallStreetBets
Yoloer.
These traders ride the waves
of popular opinion, often
finding their strategies in
the most upvoted posts on
forums like /r/WallStreetBets.
Their approach is akin to
gambling, relying more on luck
than analysis. They lose money
consistently, and never seem
to learn from their mistakes;
they blame “the Market Makers”
for “rigging the market
against them”.
Eventually, realizing that
I’d have better luck going to
Vegas, I evolved into a better
trader. Let’s call it
Category 2: the independent
systematic trader.
Oftentimes, these types of
folks used to be
WallStreetBets Yoloers, but
have learned the hard way that
following the crowd doesn’t
work. These traders often
maintain trade journals,
reflecting on their decisions
to improve future strategies.
Embracing technology, they
often use APIs for efficient
trading. However, when faced
with unpredictable market
movements, emotions can still
cloud their judgment, leading
to panic-driven decisions and
regret when the market
eventually stabilizes.
Many people quit after this
stage because they are still
unprofitable. But those that
make it through evolve to the
final category of traders:
Category 3: the algorithmic
trader.
This trader doesn’t just use
computers to execute their
trades; they use computers to
formulate them. They
understand strategy
optimization, how to prevent
overfitting, and how to make
their strategies
generalizable. They understand
that the best way to beat the
market is to have a rigourous
systematic approach. They use
backtesting to confirm their
hypothesis, and then
paper-trade after they think
they’ve developed an edge.
When their portfolio drops
suddenly, they don’t panic,
because they understand that
it’s mathematically impossible
to win every single trade.
These are the traders that are
profitable when the year
ends.
There’s a common
misconception that you have to
be a MIT PhD student to become
an algorithmic trader. But
this is far from true. Thanks
to the advent of Large
Language Models, anybody with
a computer and wifi and learn
to become an algorithmic
trader. This article will show
you exactly how.
Using Advanced Algorithms To
Your Advantage
There is not a single trader
on Wall Street browsing Reddit
to inform their decisions.
Traders that are actually
profitable are utilizing
advanced algorithms to craft,
improve, and deploy their
trading strategies. It’s
finally true that retail
investors have access to these
same type of algorithms.
NexusTrade
is a platform that brings
WallStreet-like tools to
retail investors. By creating
a free account, users can
perform financial
research,
craft algorithmic trading
strategies, and
deploy those strategies
live to the market.
However, the purpose of this
article isn’t to show all of
NexusTrade’s amazing features;
it’s to show how to use
mathematics to to improve your
trading strategy. The best
part is, you don’t need a PhD
in math to understand.
You see, NexusTrade offers a
unique feature that other
similar platforms don’t offer:
its genetic optimization
engine. “Genetic Optimization”
is a unique,
biologically-inspired AI
algorithm that’s capable of
finding amazing, diverse
solutions in a sea of
potential candidates. It works
by using
computation
to mimic the process of
natural selection — the way
real-world organisms adapt and
evolve in their
environment.
For more information about
Genetic Algorithms in general,
check out the following
article:
For details on how these
algorithms work under the
hood,
check out this article:
NexusTrade makes utilizing
these genetic algorithms
simple for everybody, even
non-technical users. Let’s see
how.
The Algorithmic Trader’s
Secret Weapon: Trading
Strategy Optimization
Genetic algorithms take your
current portfolio of
strategies and improves it
based on historical data.
Users can configure how they
want these algorithms to work
on their portfolio within
NexusTrade’s easy-to-use
UI.
There are
A LOT
of configuration options
available. For 90% of
use-cases, the default options
will work fantastically.
However, for the savvy
algorithmic trader, I’m going
to explain what each of these
configuration options do to
the optimization
process.
The Genetic Optimization
Configuration in
NexusTrade
The Date Range
To start, let’s look at the
start date
and
end date. This defines the range that
the genetic optimization will
act under. If the user thinks
that more recent data is
relevant for their portfolios,
they can choose a narrow start
and end date. If the user
thinks all available data is
relevant, they can choose a
wider range. NexusTrade gives
the users flexibility to
optimize over what time period
they want.
Our Population
Characteristics
Next is the
population size
and the
number of
generations. These attributes dictate
how many new portfolios will
be generated, and how long the
optimization process will
occur for. The bigger these
numbers are, the more
computation
that these portfolios will
undergo. That means it’ll take
longer for the optimization
process to terminate. However,
theoretically, we should
generate better solutions the
longer this optimization runs
for.
Out-thinking
Overfitting
Now, let’s talk about
number of windows. This configuration option is
useful for trying to prevent
the weakness of all
optimization algorithms:
overfitting. With number of
windows, we split the training
set with this variable, and
perform an average over the
performance of each window. In
contrast, the traditional
approach is to maximize the
performance over one giant
window; which is great for
backtesting, but tends to fall
short in real-world trading.
By segmenting our training set
into windows, we reduce the
liklihood of overfitting and
improve the chances that are
portfolio’s performance
translates into real-world
trading.
Initial positions is another tool in our
overfitting-prevention
toolbox.
The different options for
“Initial Positions”
When running a genetic
optimization, we run backtests
on historical data. The
positions in those backtests
can be configured: we can
choose to copy the same
positions that our portfolio
has right now (All), make the
portfolio start with no
positions (None), or we can
choose to randomize our
initial positions. Each option
serves a different use-case,
and the savvy trader might
pick a different option
depending on current market
conditions.
Improving Our
Population
Next, we have two special
options that affects our
population.
Elitism rate
defines how many of our best
individuals will automatically
make it to the next
population. Typically, because
genetic algorithms favor elite
individuals, we don’t need
this number to be particularly
high, and the higher it is,
the more likely it is for our
population to converge
prematurely.
Next is
spontaneous generation
rate. In genetic optimization,
typically all new individuals
are born from their parents,
just like in the real-world.
Spontaneous generation is a
unique option that allows us
to generate a completely
random individual
de novo. This individual will then
be added to the population.
This is a way to increase the
diversity of our population,
and continuously add new
individuals by increasing our
potential solution space.
However, genetic algorithms
work by continuous
improvement, and thus, this
number typically doesn’t
exceed 10% of the
population.
Next we have our mutation
parameters:
mutation rate
and
mutation intensity. Mutation rate defines the
probability that a new
individual will experience a
mutation. Think of it as a
random variation in the
strategy. Mutation intensity
defines how strong a mutation
is if it occurs. A high
intensity will completely
change a parameter in the
individual semi-randomly,
while a low intensity will
only make small changes in an
individual, as if nothing had
occurred at all. These
parameters are also useful to
improve the diversity of a
population.
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The Statistician’s Secret
Weapon
Next we have one of the most
important metrics to measure
if our strategies are
overfitting:
the train/validation set
ratio.
This ratio defines what
percent of our data will be in
the
training set,
the part of the optimization
that we use directly use, and
what percent will be in the
validation set,
the part of the optimization
that isn’t used to train our
portfolios. Typically, if our
training set has high
performance by our validation
set has low performance,
that’s a signal that our
portfolios are
overfit, and won’t translate well for
real-world trading. If our
validation set performance
matches our training set
performance, then we have more
confidence that our portfolios
will perform well in
real-world trading.
Our Fitness Functions
The last configuration option
available to NexusTrade users
is the most important: out
fitness functions.
Fitness Functions in the
NexusTrade platform
When optimizing our
portfolio, we have to make a
decision:
how
will we optimize it? What is
important to reach our goals?
Should we focus on improving
our percent gain, and earning
the most amount of money
possible? Or, should we focus
more on minimizing our
drawdown, so we don’t lose the
money that we gained?
NexusTrade gives users the
flexibility to perform
multi-objective
optimization, which means we can select
as many fitness functions as
we want. Typically, we tend to
select 2, but with larger
population sizes, we can get
away with selecting 3 or
4.
These fitness functions tell
us exactly how our new
portfolios will be better than
our original portfolios. They
allow us to customize the
optimization process to be
tailored for our unique goals.
This is what makes the
NexusTrade platform so dang
powerful.
Summary and Conclusion
Most traders never make it
past
Category 2. Before the advent of Large
Language Models, it was nearly
impossible for a non-technical
trader to utilize these
advanced algorithms for their
portfolios.
Yet,
NexusTrade
makes this process seamless.
Users can create, update, and
optimize their trading
strategies easily, in a
no-code user interface. It’s
free, fun, and powerful, and
other platforms lack the power
that NexusTrade offers.
NexusTrade offers a paradigm
shift in how traders approach
the market. Gone are the days
where you’re hopping on
WallStreetBets to gamble your
money away. It’s time to take
your trading to the next
level, and use sophisticated
algorithms to your
advantage.
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