The "Hot" Trading Systems Trap

I was recently scanning some performance databases of various trading systems and

CTAs and noticed that almost all the tracking services have some form of a "hot list". These were usually a list of the best performing systems or CTAs over a given period. The typical time frames for measuring performance were usually 30 days, 90 days and a year. These lists are of interest to many viewers because they are consistently reported by all the leading tracking services year after year. The question is thisAre those lists of any value?

It has long been my contention that such information is near meaningless. I have always felt that the best performing systems and CTAs of the past were not likely to be the best performing ones moving forward. To test my theory, I accumulated data from several of the top performance reporting sites. What I wanted to see was the previous 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 reliable predictor 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 easy as finding something that has done well and just assuming it will continue to do well. What we have seen is that often times the best time to enter a program is AFTER it has gone through a bad spell!

Jack Schwager, author and futures 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 winning CTAs produce a "stair stepping" pattern higher, a series of peaks and valleys on the way up. What Schwager's study found was that many people would buy into that strategy on a peak, right after a winning streak. Then, when the inevitable pullback or valley came they would exit at a loss! So despite the system or CTAs long term winning 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 explore the subject of finding suitable trading systems or CTAs in part two of this series.

Dean Hoffman

DH Trading Systems

The "Hot" Trading Systems Trap

By: Mark Soltys

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