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Do you think Walk Forward Analysis is a good method to estimate the predictability or edge of a trading system? Are there similar methods to know (estimate) how much alpha can capture an algo (in the future)?

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up vote 7 down vote accepted

The term "Walk Forward Analysis" typically comes from technical analysis schemes. If that's the case here, I would be careful with whatever you're considering (or reading).

Even if you tune your model parameters (and I'm not talking about any TA scheme) with 80% of the data and then "check" your model with the remaining 20%, you're still using that last 20% to determine if your model is useful. As a result, whatever model you assemble/test/retest, the reality is, even if there is a solid basis for the structure of the model, the only way to prove its value is to use it in real time. So, it is worthwhile to build tests that allow you to dump your model at the first sign of trouble.

From personal experience, I can tell you that you'll dump far more models than you'll keep.

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I found a very good process for running a walk forward analysis in The Encyclopedia of Technical Market Indicators, Second Edition: http://www.amazon.com/Encyclopedia-Technical-Market-Indicators-Second/dp/0070120579 .

The approach in the book helps mitigate the problem described above of assemble/test/retest. When you finally implement a trading system, it should have a good chance of success.

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Can you summarize this 'good process' so we can make an educated guess about it's merits, before committing time to study the recommend book? –  Jura25 Mar 19 '12 at 19:51
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