Cybernetic Trading Strategies: Developing a Profitable Trading System with State-of-the-Art Technologies

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An Overview of Advanced Technologies

Advanced technologies are methods based on machine learning or on analysis of data and development of models or formulas. I have used many different advanced technologies in developing market timing systems. These technologies include neural networks, machine induction methods, and genetic algorithms. This chapter gives a technical overview of each of these methods and introduces chaos theory, statistical pattern recognition, and “fuzzy logic.”

THE BASICS OF NEURAL NETWORKS

Neural networks are loosely based on the human brain but are more similar to standard regression analysis than to neurons and synapses. Neural networks are much more powerful than regression analysis and can be programmed for many complex relationships and patterns that standard statistical methods can not. Their effectiveness in pattern recognition makes them ideal for developing trading systems.

Neural networks “learn” by using examples. They are given a set of input data and the correct answers for each case. Using these examples, a neural network will learn to develop a formula or model for solving a given problem.

Let us now discuss how a simple neural network works. Artificial neural networks, like the human brain, are composed of neurons and synapses. Neurons are the processing elements of the brain, and synapses connect them. In our computer-simulated neural networks, ...