The Drawbacks Of Using “Hot” Trading Systems

I was recently checking some performance databases of numerous trading systems and CTAs and noticed that almost all the monitoring services have some kind of a “hot list”. These were usually a list of the best performing systems or CTAs over a given interval. The common time frames for measuring performance were typically 30 days, 90 days and a 12 months. These listings are of interest to many readers because they are consistently reported by all the leading tracking companies year after year. The question is this…Are those lists of any value?

It has long been my contention that such information is near worthless. I have always felt that the best performing systems and CTAs of the past were not very likely to be the best performing ones going forward. To test my theory, I gathered data from a number of of the top performance reporting websites. What I needed to see was the past year’s best performers to compare them to the best performers of the next year. The idea was to see if last year’s winners were a dependable forecaster of next year’s winners.

The results of comparing many years of previous performance to the subsequent years of performance were as I expected. The information about which systems and CTAs had done the best was practically useless. It, in no way, was predictive about which methods were GOING to do the best. What this means is that all those “Hot Lists” are potentially misleading. They can lure people into the idea that these are the best possible systems or CTAs they can be investing in, when nothing could be further from the truth.

What this means is that finding good trading systems or CTAs that are going to pay off is going to take work. It is not going to be as simple as discovering something that has done well and just assuming it will continue to do well. What we have observed is that often times the best moment to enter a system is AFTER it has gone through a bad spell!

Jack Schwager, writer and commodities industry icon, did an intriguing study in his excellent book Managed Trading Myths and Truths. In it, he found that many winning CTAs have many losing clients! The reason is clear. Most successful CTAs provide a “stair stepping” pattern higher, a sequence of highs and valleys on the way up. What Schwager’s research study established was that lots of individuals would buy into that strategy on a high, right after a winning streak. Then, when the inevitable pullback or valley came they would exit at a loss! So in spite of the system or CTAs long term successful track record, many clients lost money investing in it. In Schwager’s opinion, this was “the single biggest investor blunder”.

This was not to imply that investors should invest in a losing manager. Rather, they should separate deciding who is an excellent manager from timing WHEN to get into that program. Once again, the best time to get into a decent managers program is often after it has gone through a rough period.

So the question becomes, how can investors find a suitable manager if viewing past performance alone is not robust enough?

We will delve into the subject of finding suitable trading systems or CTAs in part two of this series.

Yet, I can not think of one day trading system from even 5 years ago that is still working today. On the other side of the spectrum, let’s look at trend following approaches. Trading System What this does is looks at every possible start date over time (for example 10 years).

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