The Widespread Blunder of the "Hot" Trading Systems Trap

The “Hot” Trading Systems Pitfall

I was recently checking a number of performance directories of numerous trading systems and CTAs and noticed that almost all the monitoring 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 12 months. These listings are of interest to many readers since they are regularly 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 data is near worthless. I have always thought that the best performing systems and CTAs of the past were not very likely to be the best performing ones moving forward. To test my theory, I accumulated data from a number of of the top performance reporting sites. What I wanted to see was the past year’s best performers to compare them to the best performers of the next year. The thought was to see if last year’s winners were a reliable 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 worthless. It, in no way, was predictive with regards to which methods were GOING to do the best. What this suggests is that all those “Hot Lists” are potentially misleading. They can lure individuals 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.

Discovering excellent Trading Systems or CTAs

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 finding something that has done nicely and just presuming it will continue to do well. What we have seen is that often times the best moment to enter a system is AFTER it has gone through a bad spell!

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

This was not to mean that investors should invest in a losing manager. Rather, they should distinguish between deciding who is an extremely good 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 difficult period.

So the main issue becomes, how can investors find a suitable manager if using past performance alone is not effective enough?

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

Dean Hoffman
DH Trading Systems

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