This is why all trading systems lose

Is there a bigger game of mental masturbation in finance than our collective obsession with the perpetual money machine? The single greatest lie in the markets is that we can just create a 24/7 trading algo that will print money for us the way the Fed prints credit.

It doesn't matter if you are an MIT finance professor like Andrew Lo, a multibillion dollar fund like AQR or just a regular joe schmoe with a simple moving average MetaTrader EA, real life markets will always decimate whatever well crafted piece of statistical wizardry you’ve created. Don’t take my word for it. Just look at long term records of these systems - not the beautifully curated, irrefutably argued backtests - but the actual real life performance and you quickly realize that a  stack of T-bills would have done a better job and cash under the mattress wouldn’t have done much worse.

The latest darling to fall victim to the harsh bitch slap of life is the Dual Momentum strategy - which I must admit I really liked on intellectual grounds - but as Michael Harris in @priceactionlab notes, this super-duper-much-better-than-the-index approach  got absolutely pulverized over the past eight years as the correlation between stock and bonds went from negative to positive.

Why do all systems fail in the end? Because we are always focusing on the wrong problem. As system creators all of us - and no one more guilty of this than yours truly - obsess over every minor detail of the how. Is the time range correct? Should we use a VWAP filter? Can we go 10 million years in the past to show how well it worked in the The Pleistocene Epoch?

You get the idea.

But here is the dirty little secret of system trading. The “how” doesn’t matter. Well it matters a bit, but just a little bit. All real market success of system trading depends on “when” not “how”. The truth of the matter is that there is no system in the world that will not be destroyed by some mutation of the market regime that will appear in the future. And it doesn’t matter if you trade on the minute chart or never look at your investments for decades. Think buy and hold is sacrosanct?  Ask a Tokyo bag holder who bought the NIkkei at 38,957.44 and is still under water by more than 10,000 points thirty plus years later. As John Maynard Keyens - one of the greatest investors that ever lived - once quipped, “In the long run we are all dead.”

In the BK chat room we trade on the one minute chart, which certainly can seem overwhelming to some but the upside is that we get feedback very quickly and fail fast. Nothing has made a bigger impact on our P/L  then when I learned to turn the algo OFF. The system trades the rules that have been in place for years, except now the algo goes to sleep for large swaths of the global day - and guess what? Unlike in real life, doing nothing in the markets is actually a lot more profitable. 

Please note that I am not arguing that simply turning a system on or off will solve all of the profitability problems. Trading will always remain an art as much as a science because volatility and correlations (just a fancy way of saying people’s reaction to the news) will be different going forward than they were in the past. But here is what I know for sure. There is no good trading system. There is only a trading system good for its time.  It’s never really about the how. A simple straight line on the chart is as good as a multivariate function. It’s always a matter of “when”, so take all the  magic money machine claims with a barrel of salt. In the end they are always a lie.