Modeling Maximum Trading Profits with C++

Preface

From 1993 to 1995 I had been working on a project at Merrill Lynch of Japan in Tokyo. The project dealt with the development of trading systems that make automatic buy and sell decisions on futures, equity, and foreign exchange markets. The books of Perry Kaufman (1987), Robert Pardo (1992), and John Koza (1992) were driving forces of the project during this period. I was particularly interested in the book of Robert Pardo, which had become quite popular and quickly got the alternative name “The Black Bible.” The adjective and the noun respectively reflected the color design of its front page and the short but relevant content.

The concept and description of potential profit attracted my attention because Robert Pardo believed that the idea of what the market offered was not a widely understood. He proposed a simple algorithm to compute this property. This algorithm buys every bottom and sells every top. I thought that under real conditions transaction costs could easily turn some of these trades into losses, even if they were successfully entered and exited at local bottoms and tops. I wanted to include this factor and began by manually trying different values to see how costs affected individual transactions and the final profit and loss. Surprisingly, I determined that the algorithm becomes substantially more complicated. Often, after the strategy was built and seemed to be generating the maximum profit, I was able to redistribute the transactions and get even more profits. ...