Curve Fitting and Over-optimization
A major stumbling block for many market timers is the phenomenon of curve fitting. This means that a given set of trading rules has been over-optimized to fit the particular dataset for which it has been back-tested. Unfortunately, if the trading rules are over-optimized they often fail to work on future data. Market timers attempt to avoid these difficulties in a number of ways. One is by looking for clusters of parameter values which work particularly well. Another is using out-of-sample data, which ostensibly allows the market timer to see how the system will work on unforeseen data. However, critics charge that once the strategy has been revised to reflect such data it is no longer "out-of-sample".
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