In This IssueValidating Trading SystemPerformance1Tech Talk4Market StatisticsUpdate & IPOs__ 5, 6 & iProduct Summary8

Editor: Sabrina CartePublisher : Commodity Systems, Inc .Layout/design: Moran Advertising, Inc .

Notice : The views and informationexpressed in this document reflectexclusively the opinions andexperience of the author, Robert C .Pelletier. NEITHER CSI NOR THEAUTHOR UNDERTAKE OR INTENDTO PROVIDE TAX ADVICE ORTRADING ADVICE IN ANY MARKETOR ENDORSE ANY OUTSIDEINDIVIDUAL OR FIRM . ALLRECOMMENDATIONS AREPROVIDED FOR THEIR INFORMA-TIONAL VALUE ONLY . Readersshould consult competent financialadvisors or outside counsel beforemaking any trading, softwarepurchase, or investment decision . CSIdoes not stand behind or endorse theproducts of any outside firms .

Advertisements Enclosed: We haveenclosed advertisements for AngusJackson Inc. - A Commodity FuturesBrokerage Firm, and Trading. AnExact Mathematical Science offeredby Market Timing Group.

CSI accepts advertisements toaccompany our Technical journal forthe sole purpose of defraying postagecosts .

Copyright © 1998 Commodity Systems,Inc. (CSI) . All rights reserved .

Validating Trading System PerformanceMining profits from the futures

markets can be an arduous task. It is,however, a pursuit that many havefound rewarding. The most successfultraders I know owe their success to thedevelopment of a market tradingsystem based upon decades of pastmarket behavior. With the help ofyour computer andavailable marketdata, you, too, candevelop such asystem .

t6eAlthough it istempting toconclude thatyour approachmerits riskingyour hard-earned capital,you should beaware of some rules andcautions before taking thatultimate challenge.Select the Right Input

CSI's new Unfair Advan-tage-' (UA) product has given you thetools to transform your commoditydata into unique variable time series .Any of UA's Computed Contracts allowa string of successive contracts toappear almost like a stock, spanningmany decades of history in a singletime series . With UA, you can formBack-Adjusted series that concatenatemany futures contracts, or formPerpetual Contract° Gann contract,Nearest Future and Open Interestweighted series. Choosing a data seriesis the first step in developing a success-ful trading system .

Once you have evaluated andchosen one or more of these many

alternative methods for expressing datainto the past, you must identify yourmarket trading algorithm and test itsability to deliver trading profits .*Limit Parameter Control

Every process you consider requiressome level of decision-making controlto force a market profit. Your trading

algorithm should have atleast one trigger to explic-itly buy or to sell a given

commodity, and totake a profit or aloss as time andmarket conditionsunfold. Thesetriggers, calledparameters, can beused alone or inconjunction withother triggers todevelop specifictrading signals.Overcomplicatingthe decision thatgets you into the

market tends to consume statisticaldegrees of freedom. The more freedomyou take out of the market (addingprocess control), the less chance yourtrading algorithm will be successful .Factors such as commissions, slippageand inevitable errors made by youand your paid partner, the broker, allimpact the likelihood that the marketwill pay back your risk capital.Excessive parameter control artifi-cially minimizes their impact .

Try to limit the number of param-eters introduced to five or less . Ithelps if each chosen parameter isindependent of each other parameter,

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the

toreV10MOSSA'ahis

"You cannot profitfrom inflation unlessyou are a bank, so donot confuse earningsfrom inflation withprospective profits."

Validating Trading ...(continued from page 1)

but if there is some dependency,parameter consumption will not be asgreat. As you can see, there is an art toparameter counting. The point is thatyour algorithm should consume as fewparameters as possible . If you can finda one-or-two parameter approach fortrading that keeps risk at a minimum,you may be surprised with the successthat results .Avoid Price-Determines-Price Modeling

Using the past history of a commod-ity to predict the future price of thatcommodity is worthwhile only if youcan separate cyclical and seasonalforces from other market forces . In thecorn market, for example, cycles andseasonal forces repeat with greatreliability and consistency because thecorn crop depends upon the weatherand other agricultural forces . Thesecyclical patterns can be seen overdecades, not just a few years. Toconclude that a different approach(such as a brief analysis using amoving average crossover) will givethe same visibility is an invitation foran unfortunate response.Watch the Effects of Weather onCommodity Pricing

Many seem to be surprised by thecurrent drop in prices of gasoline atthe retail-leveL-Gasoline, recentlyoffered at $1 .29 9/o, is now priced aslow as $ .89 9/o, according to TV newsreports. To see why this has happened,you need only look at the wintertemperature reports in the northernstates. Thanks to El Nino, we haveexperienced one of the warmestwinters on record, which, in turn,drastically reduced the demand forheating oil . Oil refineries overproducedthe heating oil in anticipation of acold winter and must now store theexcess . Both heating oil and gasolineare derived from crude oil, so thediminished demand for heating oil hasshifted production resources to gaso-

line. As a result, the oil companies nowhave a substantial surplus of gasolineas well as heating oil. Thus, the supplyand demand curve has pulled downthe retail price. Energy market specu-lators have been seeing the effects ofthis in the futures prices of unleadedgas, heating oil, etc .Avoid Confusing Inflation andDeflation with Achievable Profits

You cannot profit from inflationunless you are a bank, so do notconfuse earnings from inflation withprospective profits . You can avoidinflationary effects by detrendingyour time series input with LA whileforming any computed series . Anotherway to take inflation out of yourseries is to present every trade incurrent dollars through time-baseddiscounting . This would have to beprogrammed into your algorithm byinflating or deflating past historicalprofits into today's dollars, but remem-ber that the discount rate will varyover time according to governmentwhims and priorities.Search for Directly and IndirectlyCorrelated Independent Variables

More sophisticated and profitablesystems are often derived from theinsight offered by related markets . Ifyou want to trade the Lean Hog-market, for example, it would make agreat deal of sense to factor in theeffects of markets related to hogs . Lookat the price of corn (a raw material)and live cattle (a substitute for pork)in relation to the price of hogs . Factorin the cost of the oil-based energyproducts on the planting, production,and harvesting of corn, etc . Similarly,if you are interested in corn, you willwant to know the price of not onlyenergy, but also the price of substi-tutes such as oats, wheat and soybeans .

The commodity you have chosen totrade (the dependent variable) canbest be understood by factoring in the

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markets that it competes with and themarkets from which it is derived (inde-pendent variables). Any viable predictiveapproach will draw from many indepen-dent inputs before suggesting thedirection of the dependant variable."Examine Long Periods of Past Data

The historical period you use tosimulate past performance should besufficient to prove that your approachmeets the test of time. When simulat-ing the behavior of agriculturalmarkets, stable factors such as theweather have had consistently reliableeffects that repeat over and overagain. Many markets respond toseasonal influences, and if you findthat these forces are present, you willbe the better off from their discovery.The more history you study, the bettersolution you will find.Diversify Your Investments

As a concept, diversification iseasily explained as simply not puttingall your eggs in one basket. If only itwere this simple! The problem withdiversification is that it is much easiersaid than done. While clearly a traderwho invests only in Hogs is not diversi-fied, what if he invests only in livestock?What if a trader were to spread hisinvestments over a broad range ofagricultural products or a basket ofcurrencies? Would he be diversified then?

I would argue no. An often over-looked hurdle to diversification is thefact that the underlying economy andits currency impact all markets withintheir scope. Catastrophic weather ortransportation problems within acountry will affect most commoditiesin the region. Similarly, the tighteningof credit or a shift of currency valua-tion relative to other nations canimpact multiple markets. I believe thattrue diversification requires multina-tional investments, covering a broadscope of markets, traded in a varietyof currencies.

Avoid Small SamplesThe approach you ultimately

decide upon must be proven withperhaps 30 to 100 trades over thehindsight past. Each simulated trade isa sample of one. You will need manysamples to prove that you have aviable approach . Although this isrelated to studying large amounts ofhistory (above), it is not necessarilythe same. An algorithm derived from30 years of market data that indicatesonly a few trades over that time maynot prove to be statistically viable.Consider removing as many of thelargest profits as the number ofdegrees of freedom you have con-sumed. This rule-of-thumb correctionwill help to remove the uncertaintyof capturing the rare huge profitablemoves that mean the differencebetween profit and loss .Prove Your Approach Before Investing

Once you are confident that youhave a viable trading method, papertrade your approach for a prolongedperiod. Take notes on your anxietiesand your decision-making processes .Give consideration to your reaction tolarger drawdowns and consider whatyou can do to minimize them . Try toavoid zero-sum solutions, whichdeliver zero profits, less losses andcommissions. A moving averagecrossover study with no other sub-stantive input is typical of a zero-sumgame.

So that you won't be too overconfi-dent in your approach, let me say thatthere is an infinity of approaches thatwill deliver hindsight profits, regard-less of the method you choose . It willbe your job in this exercise to separatethe random from the predictive.***This article is meant to offer you somehelp in making the right choices .

Additional resources:

Check out your finishedapproach with an actual, no risk,market test using Gene Donney'sAudit Trac simulated brokeragesystem. Phone: (561) 393-3876

"" Louis Mendelsohn's NeuralNetworks and Interactive tradingapproaches draw heavily on thisthesis . Phone : 800 732-5407

""Investigate Nelson Freeberg'sFormula Research for more onanalytical methods that Nelsonproves before he publishes .Phone: (901) 767-1956

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Each month in thiscolumn, our technicalsupport staff presentstopics of interest tomany subscribers in aquestion-and-answerformat. This monththey address somefre-quently asked questionsabout QuickTrieveO andUnfair Advantage.

Correction :

The February '98 Tech Talksuggested uninstalling UAbefore upgrading to a newversion if you were havingproblems with the program .Uninstall should be usedONLY if you have a new CDfrom CSI, not when upgrad-ing from our web site.

Tech Talk

Q. 1 am impressed with UnfairAdvantage's° data coverage and ease ofuse, but I have run into one problemwith updates. You recommend usingthe Internet for retrieval (I live inAustralia), but my connections havebeen slow and sometimes unsuccessful.My local Internet Access Provider ran atrace and found that the delay was inCSI's servicing ISP When can I expectimprovement?

A. An MCI line will be installed onApril 6th with service to begin nearthe end of that week. We expect greatimprovements at that time. We havehad conflicting reports about overseasservice, some offering praise forimproving our service, even before theaddition of the new server . Neverthe-less we want better response for ourusers and we acknowledge that at leastpart of the problem lies with ourparticular ISP. We have been veryconcerned about the problem forseveral weeks, but had been consis-tently told that the problem could bewith any one of the connecting nodes(of which there could be as many as20 and as few as perhaps 10) betweenthe caller and CSI. We will explore ourISP service until we correct all prob-lems over which we have control .

Q. Sometimes, after UnfairAdvantage retrieves my daily update,it doesn't distribute the data. At thatpoint, is my only option to retrieve thedata again? If so, do you charge me forthe extra accesses?

A. It is difficult to tell why a distri-bution might be missed. It can meanthe data collection was incomplete, orit may mean that the program simplyfailed to move on to the distributionprocess. In either case, you should tryto manually distribute the data bypulling down the Database menu and

clicking Distribute. If the data is there, itwill be distributed to your files. thusavoiding a repeat data collection .

If, on the other hand, a messagedisplays saying "no update file found,"you will need to update your databaseagain through the Internet or yourphone line. You will only be chargedfor extra accesses if they are used tore-collect data that has already beenretrieved during a successful down-load session .

Q. What is going on with my LIFFELong Gilt data? All of a sudden, thevalues don't look quite right.

A. Cash market reforms and innova-tions have necessitated changes to theLong Gilt futures contract on LIFFE .Chief among these are the reductionin the Notional Coupon from 9% to 7%,and a move to decimalization. From theJune '98 contract forward, the contractis now 7% Gilts . From the September'98 contract forward, the pricing is indecimals, and the contract size isdoubled to 100,000 pounds sterling .

As a result of these changes, theCSI conversion factor for commodity174 had to be changed from -3 to +2.To present future data correctly,QuickTrieve users should edit yourCommodity Constants to reflect thenew conversion factor (+2) and thenew contract size. This will affectnew contracts only. Use Edit DataDisk Master File to change thesevalues for your current Long Giltcontracts from 9/98 forward. Allother existing files should be storedwith the former (and appropriate)conversion factor and contract size .

After the close of business on980501, the June '98 contract will bepriced in decimals, too . Unfortunately,there is no way for QuickTrieve tohandle a mixed conversion factorwithin a single futures contract .

We have automatically changed

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the factsheet for Unfair Advantageusers to reflect the conversion factorchange. To see historical data as in 32nds,temporarily change the fact sheet toshow a conversion factor of -3, uncheckthe Apply Adjustments setting on theView, User Settings, General tab . To seedata in hundreths, leave the conver-sion factor of +2 and check the ApplyAdjustments setting. There is no longera way to simultaneously view a com-modity in multiple conversion factors .

Q. Igot Unfair Advantage severalmonths ago, and my copy does nothave some of the features mentionedin the CSI TechnicalJournal. How can Iupdate my software?

A. Visit the UA upgrade web page athttp://pcweb.csidata.com/ua/uax.htmto download the latest version . Ourlatest upgrade (Version 1 .68) offersenhanced stability and saves lots ofspace by correcting errors on the flyand saving them permanently in thecompressed database . All the changesrecently promoted in the Back Adjustmodule are now working also . Thisfree upgrade is the best version yet!

Q. After using UA for viewing manycharts, my computer sometimes growssluggish and occasionally crashesWhat can I do to avoid this?

A. Under certain circumstances, mostcommonly involving UA's API, thecurrent version is subject to memoryleaks. These cause excessive memoryconsumption and can result in thesymptoms you mentioned. To reducethe incidence of memory leaks, werecommend that you tailor yourportfolio(s) to include only thosecharts which you regularly view, andthat you avoid saving charts to disk .

Eliminating memory leaks is highon our priority list for upcomingversions of UA . Please check oursoftware upgrade web page frequently

to make sure you get the enhancementas soon as it becomes available. Weexpect improvement in the near future .Note to Windows 3 .1 Users:

All recent upgrades of UnfairAdvantage (v. 1.59 and above) supportonly the Windows® 95 and WindowsNT operating systems. We stronglyrecommend that all Windows 3.1 usersupgrade to Windows 95.

Market Statistics UpdateADDITION TO THE COMMODITY DATA BASE

Commodity

Short 5-Year GiltCSI commodity # : 504

Symbol : FYGExchange:

LIFFE (London)Unit of measure:

Percent Contract size : GPB 100,000Delivery months :

3,6,9,121st day on file:

980226 CSI point value : GPB 10 .00Conversion factor : +2

Newspaper/CSI price : 102 .72/10272Limit (price) :

None

Max months forward : 10

DELETIONS FROM THE STOCK DATA BASE

29117 AMVCW29118 AMVCZ4669 ACARE29460 ASILZ18040 ASIL29459 ASILW8928 AMTX6500 AST29214 AQCRW29213 AQCRU2095 ATCS12325 ATCSL7023 ATE18405 BKUNO8219 BIRD1581 BIRDP9983 BWLKW12844 BYDSQ11256 KAP3677 CVL7760 CSA8322 CELS3389 DKT8498 DBAS5727 DEW4173 EIRE15957 GETTY15389 GLOB15414 GLOBW1614 GTFN2700 HDTC4381 HLMS2393 HMCI11474 HSL8934 MPAC5114 ITT1428 LIFB2399

LNTV

Advanced Machine Vision Cp CI A WtAdvanced Machine Vision Cp CI B WtAegis Consumer Funding Group IncAlcohol Sensors International Inc Cl B WtAlcohol Sensors International LtdAlcohol Sensors International Ltd CI A WtAmati Communications CpAmeristeel Cp Cl AAqua Care Systems Inc CI A WtAqua Care Systems Inc UnATC Group Services IncATC Group Services Inc Cl C WtAtlantic Energy IncBankUnited Financial Cp Perp PtdBird CpBird Cp $185 Cum Conv PfdBoardwalk Casino Inc WtBoyds Wheels IncCapmac Holdings IncCelumovil SA ADSCoast Savings Financial IncCommnet Cellular IncDakota Mining CpIDEA Systems IncDelmarva Power & Light CoEmerald Isle Bancorp IncGetty Communications Plc ADRGlobal Med Technologies IncGlobal Med Technologies Inc CI A WtGreat Financial CpHealthdyne Technologies IncHolmes Protection Group IncHomecorp IncHomeside IncImpact Systems IncITT CpLife Bancorp IncLin Television Cp

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CSI will be closed onFriday, April 10 for theGood Friday holiday, butthe computer will beaccessible as usual through-out the holiday weekend.If there is an emergencysuch as the server goingdown, you may e-mailtechsupport@csidata.comfor assistance. Pleaseinclude specific informationabout the problem andinclude your Customer ID,user #, the name andversion number of thesoftware you are using, andyour method of access (e.g.Tymnet, Telenet, direct dialor Internet). We will try toresolve the problem in atimely manner.

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