When optimizing a trading system, the first question we must answer is what it is that we are trying to maximize.  We can call that our fitness function.  I’m quite a newbie in this area, so the fitness function that I use is not presented as a recommendation, but rather a simple recording of where my thoughts on the process currently reside.

First of all, I do not want my fitness function to be dominated by recent results, so I do not “reinvest” my profits when testing a system;  I presume that I have a fixed starting equity for every trade and risk a percentage of that equity. 

Secondly, since the Cable Glider is quite profitable, the equity curve quickly looks like an exponential function, so I use logarithms whenever possible in order to normalize various pieces of the fitness function that would otherwise be on entirely different scales.  This is  an attempt at finding a fitness function that is not dominated by a single sub-component.

Thirdly, I think what I like and what I don’t like.  I like profit.  I dislike losses.  I like a high winning percentage.  I like the average win size to be greater than the average loss size.  I dislike drawdowns.  I want to be certain that I have a quantifiable edge that suggests my trading results are better than playing a coin flipping game.

I will post the specific function that I’m using in my next post.  In preparation, please read Ed Seykota’s page on risk management.  My fitness function incorporates the Kelly criterion described on that page.