Conclusion

This paper develops a way to decide if, based on a system’s past performance, the system should be traded. The decision is made through a basic hypothesis test that compares the system’s past performance to a critical value. The key is that the critical value is conditional on the price series and the system’s trade characteristics.

In this way, the test considers what performance could have been achieved given what the price actually did. The Random Signals Test is crucial to traders. Traders come across many systems with good past performance. However, if a system’s good past performance is less than some critical value, then there is a high probability that the performance is the result of chance, and so the system should not be traded.

Acknowledgments

Thanks to Mark Simms, Andreas Krysl, and Rick Luppy for helpful comments.

Prof. Alex Strashny

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