Futures and forex
traders who deploy a computerized trading system to help them trade
are a special breed of investor. They tend to go beyond the basic research when
analyzing which trading system to use and trust.
But here’s the problem:
The same zealous traders also tend to get excited about the equity curve of a
trading system. What is sometimes overlooked is that after they get in and start
using the trading system, what happens if the road gets bumpy and losing trades
replace the winning trades? Should you ditch the system, or stick with it?
I will show you a possible solution to that problem. The technique is called
Time Window Analysis. Moreover, the techniques I will discuss are applicable
to any researchable investment vehicle.
First let me tell you a little about myself. After college graduation in 1986, I
began my futures career on the floor of the Chicago Board of Trade working as a
runner on the grain floor. I progressed to doing grain market research and then
began handling client business in 1988. From that time on, I have been involved
in some capacity of futures trading system administration or management. I
haven’t seen it all, but I have seen a lot. Over the years I have written
articles for Futures Magazine, and SFO Magazine. My articles have
also appeared on FutureSource.com and Bondheads.com. I currently oversee
operations for an Introducing Broker headquartered in California, called Trade
Center.
What I am going to teach you is one technique to evaluate the performance of a
trading system so you, the investor, can better understand what to expect in the
future. These techniques are applicable to any investment; the limitation is
getting your hands on the data. Those who develop and market trading systems are
very keen to looking at Time Windows.
While it does get more complex than what I am about to say, most investors want
to know the basics about an investment or trading system:
- How much do I have to invest?
- How much can I make?
- How can I get my money back out?
Sound familiar? We all talk about planning our investments, but it seems like
the three questions above get the most attention. How about adding another
simple question:
How ugly can it get and how long will the ugliness last?
Almost nothing starts winning immediately. I have some Microsoft and Qualcomm
stock that I have had for years--with never a profitable day. The same holds
true for those using a trading system to help them get buy and sell signals.
What if you could peer back into history and know that the worst run of bad
trades or drawdown lasted four months from the peak?
Think that might come in handy when you are trying to figure out if pulling
the plug is the best thing?
Let’s look at some examples. You can obtain data from sites like tradecenterinc.com or from the individual trading system developer.
Example # 1
This trading system is down approximately $2790 on $15,000. Now for the most
important question, how ugly can it get and more importantly, how long may
this last? For that we turn to Time Window Analysis.
| Time Period |
1 Month |
3 Months |
6 Months |
12 Months |
| Profitability
Odds |
64.71% |
90.63% |
96.55% |
100% |
From the table above we can see that this system has a 64.71% probability of
being profitable in any 1-month period. Any three-month period is 90.63% and so
on.
The big key is seeing how long it takes
to make it to the 100% mark. With this valuable piece of information, I know
that I need to wait at least twelve months for my system or account to get back
to even or profitability. Obviously, this is not a certainty or guarantee, but
this information is critical in both the planning and maintenance of a system
investment. Thus, if the current drawdown is a little over seven months long, I
need to plan on sticking with it for about five more months.
Example # 2
While some systems can be successful, they do take some fortitude.
| Time Period |
1 Month |
12 Months |
18 Months |
36 Months |
| Profitability
Odds |
54.93% |
86.26% |
94.40% |
100% |
From the table above we can see that this system has a 54.93% probability of
being profitable in any 1-month period. Any twelve-month period is 86.26% and
so on.
The chart above shows us that when the big drawdown comes; you need to be able
to sit with it for three years.
Example # 3
This system is up about $4005 on a $30,000 investment for 2006. Better to
plan NOW for how to act when the drawdown comes, because it will come.
| Time Period |
1 Month |
3 Months |
6
Months |
12 Months |
| Profitability
Odds |
75.68% |
91.43% |
96.88% |
100% |
From the table above we can see that this system has a 75.68%
probability of being profitable in any 1-month period. Any three-month period
is 91.43% and so on.
What have we learned? Hopefully this shines a
light where perhaps there was none and hopefully this can be used as a corollary
to other investments above and beyond futures and forex trading systems. Have a
plan for what to do when something ugly, bad or costly happens. Obviously, you
can’t just close your eyes and wait out a twelve-month bludgeoning because the
Time Window says so, but you can go into an investment armed with some
information that gives you the edge. Ands isn’t the edge the difference between
winning and losing in just about everything?
For more information about Trade Center or to reach Scot Hicks, go to:
www.tradecenterinc.com.
