Is our communal preoccupation with the money machine an even bigger game of mental masturbation in the world of finance?
The biggest myth in trading is that we can automate our way to wealth creation, much like the Federal Reserve creates new credit out of thin air.
It doesn’t matter if you are a billion-dollar hedge firm like AQR or a basic moving average and an MIT finance professor like Andrew Lo.
No matter how carefully you’ve designed your statistical wizardry, MetaTrader EA, the real markets will always destroy it. Put no stock in what I say.
Long-term records of these systems show that a stack of T-bills would have done a better job, and cash under the mattress wouldn’t have done much worse, than what is shown in the carefully curated, irrefutably stated backtests.
The Dual Momentum strategy, which I admit I really liked on intellectual grounds, is the latest darling to fall victim to the harsh bitch slap of life.
As Michael Harris in @priceactionlab points out, 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.
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What causes all systems to eventually collapse? For the simple reason that we keep fixing the wrong issue.
No one is more of a how-obsessed system designer than I am, yet we’re all guilty of it. Is that time frame accurate? Is a VWAP filter the right choice?
Is it possible to travel back in time ten million years to demonstrate how successfully it functioned during the Pleistocene Era?
But now you know the truth about trading with a system. The method is unimportant. Yes, it does make a difference, but just slightly.
The “when,” not the “how,” determines the true market success of system trading.
The truth is that every system in the world is vulnerable to being toppled by a new variant of the market regime.
It makes no difference if you trade using a minute chart or if you don’t check in on your stocks for twenty years.
Consider the buy-and-hold strategy sacred? Just ask a Tokyo bag holder who, thirty-plus years after buying the NIkkei at 38,957.44, is still thousands of dollars in the red.
“In the long run, we are all dead,” John Maynard Keyens, one of the greatest investors of all time, famously said.
While trading on a one-minute chart in the BK chat room may appear daunting to some, the immediate feedback and low cost of failure it provides more than makes up for any initial anxiety.
The day I figured out how to switch off the algo was the day our P&L improved more than any other.
The system still executes trades in accordance with the established protocols, but the algo is now inactive throughout significant portions of the global trading day.
In the markets, doing nothing is far more lucrative than doing anything else.
Please understand that I am not claiming that enabling or disabling a single system will magically restore optimal profits.
Because volatility and correlations (a fancy word for people’s reaction to the news) will be different in the future compared to the past, trading will always be an art as well as a science.
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But here’s what I can say with absolute certainty. A reliable trading method does not exist. Only the trading system that works best in the present can be used.
The “how” is never the central issue. A straight line on a graph can tell you just as much as a multivariate function can.
Any boasts of instant wealth should be taken with a grain of salt because the “when” is always an unknown. They always turn out to be a falsehood in the end.
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