System Traders Charge through Bear Markets

Discussion in 'Strategy Development' started by Trend Following, Aug 21, 2009.

  1. Trend Following

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    The vast majority of investors use fundamental analysis for their investing decisions. They are the academics, brokers, bankers, analysts, college students, weekend warriors and Jim Cramers of the world who failed to plan for the stock market, real estate and credit bubbles of 2008 and 2009. Millions felt confident of so many rosy fundamental projections that they rode bubbles straight up and straight down with no clue when to exit as those bubbles finally burst. Many today still hang on, hoping everything will come back to “normal.”

    One of the great traders of the 20th century, Ed Seykota, nailed the problem with that wishful thinking: “One evening, while having dinner with a fundamentalist, I accidentally knocked a sharp knife off the edge of the table. He watched the knife twirl through the air as it came to rest with the pointed end sticking into his shoe. ‘Why didn’t you move your foot?’ I exclaimed. ‘I was waiting for it to come back up,’ he replied.”

    Don’t we all know an investor who is waiting for his or her market to come back? Don’t we all know an investor hooked to Ben Graham’s dollar cost averaging advice? And now we all know in our guts how wrong it was to invest based on forecasts, predictions and fundamentals. That stuff only works if you live forever.


    Look, the world changed in October 2008. Trillions of dollars were lost through a long-held belief in buy and hold. The Dow, NASDAQ and S&P 500 indexes fell like stones, and some of the biggest fundamental names crashed and burned. Nearly everyone has felt the ramifications: retirement accounts wiped out, jobs lost, firms going under and fear all around. Consider, for example, these panicked investors buried in GM investments, as reported by The Wall Street Journal, April 11:

    • Marjorie Holden paid about $40,000 for General Motors Corp. bonds, with interest ranging from 7.4 percent to 8.4 percent. Now the bonds are worth just under $10,000.

    • Bob Pandolfi, 68, a retired stockbroker from Staten Island, N.Y., saw his 1999 $50,000 investment in GM bonds plunge to one-tenth of that.

    • Harley VanDeloo, 69 bought $20,000 in GM bonds a year ago. These are now valued at less than $3,000. VanDeloo said, “I thought GM was too big to fail.”

    Worse? reports that in the past 10 years, for the largest 10 mutual funds (i.e., Fidelity and all the biggies), investors spent $21 billion in mutual fund fees only to see stocks go up and then right back down. The mutual funds were paid all this money to perform, but failed to deliver when these baby boomers were ready to retire (see Figure 1).


    The press is always fascinated with the losers, those horrible stories of grandma losing her life savings or some random nonprofit firm getting mixed up in a Bernard Madoff scam. One would assume no one made money during this awful time. But there were some big winners in 2008, and they made money in a unique, honorable and fair manner.

    How well did the winners do? During October 2008, for example, some traders made fortunes ranging from 5 percent to 40 percent. Many made more than 100 percent overall in 2008. The winners were systematic traders. Take a look at these results from the April 2009 article “The Top 25 Highest Earning Hedge Fund Managers” from Institutional Investor:

    • David Harding’s $5.5 billion flagship Winton Futures Fund increased 21 percent.

    • Most of Ken Tropin’s and Graham Capital Management’s funds earned double-digit returns, ranging from 20 percent to 52 percent.

    • “Last year [Christian] Baha’s Quadriga Superfund U.S. portfolios generated 30 percent average returns. … [Superfund] was generally short global equity indexes and long many bond markets. In the first half of the year, it was long corn, gold, oil, soybeans and wheat and then shifted strategy, shorting many of those commodities.”

    • “Bill Dunn … generated a 19.4 percent net annualized composite return since he launched his original trading program in October 1974. … His $168 million World Monetary and Agriculture program, founded in 1984, was up 51.5 percent last year.”


    First, let me state how they and other traders did not make money:

    1. They did not know stock markets would crash in October 2008.

    2. The traders did not make all of their money from shorting stocks in 2008.

    What did they do? They made big money in many different markets from oil and bonds to currencies, stocks and commodities by systematically following trends up and down without using fundamental analysis to guide their buy and sell decisions.

    Unfortunately for most people, the markets have long been positioned as action oriented. Do something. React to the latest news. Call one’s broker. Listen to an analyst. All of these discretionary activities hinge on short-term human judgments for what to do next all at the expense of any cohesive, long-term plan to make money.

    The need to exercise some type of human judgment drives the majority of market players. But what does all this action do for traders if their No. 1 goal is to profit from the market and avoid losing their life savings right before they are ready to retire? The short answer: not much. But there is hope.


    The best traders are systematic traders. Their rules of buying and selling are written. Once they establish their rules, assuming they are based on sound trading rationale, traders follow them religiously.

    What happens if a news story or some new economic numbers break? If the news is not part of the trading system, the trader does nothing. What happens if he or she loses 5 percent in one day? If the rules say to exit, the trader takes the loss and gets out—no questions asked. Consider these bits of wisdom from noted old pros:

    • “We have a pretty strict definition of a systematic trader,” Michael Garfinkle of Commodities Corp. says. “They basically follow a set series of rules, established in a computer program, that tell you when to buy or sell, how many, as well as when to get out.”

    • “Well, it may sound odd for someone who has written books about trading to say this, but I really don’t enjoy the process of trading,” Jack Schwager, money manager, says. “And by that I mean the actual decision making while the markets are active. Do I buy? Do I sell? Do I add to my position if it’s going against me? Do I get out? Do I double up? All that churning turmoil, emotional turmoil is something that I don’t particularly enjoy. What I do like is the puzzle element of it. Trying to solve the market puzzle. How can you come up with a set of rules that can ... ‘beat the market’? And that’s what I find fun. So I decided a while ago that the best course for me was to get out of the decision-making process and automate the whole procedure through system trading.”

    The American Heritage Dictionary defines a system as “a set of interrelated ideas, principles, rules, procedures, laws or the like.” Systematic trader Bob Pardo has noted that the key words are “interrelated” and “rules.”

    A trading system is a set of interconnected, mathematical formulae that can range from the simple to the extremely complex. The express purpose of these formulae is to provide buy and sell entry and exit points—or signals—for the purposes of automatic or mechanical trading. That is, trading without human judgment or intervention.

    Full article continued:
  2. As with most TASC, Futures, or other mag articles. Long on claims, opinions, cherry-picked examples/backtests, etc. Short on evidence...

    You of course, are going to supply overwhelming, statistical PROOF that systematic traders are best?

    In addition, their rules of buying and selling may be written, but you hedge your claim "assuming based on". But that is not what you were trying to prove. This holds for EVERY type of trader "Day traders, scalpers, investors, etc." Are best, assuming yadayada

    And where is it proved systematic traders follow their system religiously? ET is full of people complaining they have a clear system, but make errors, manage money poorly, cannot make money, blow out, etc.

    If you are trying to show mastery of trading, you need to stop mostly showing mastery of hype, opinion and beliefs.

    There is a reason that it is believed that 90-95% of traders lose their money. And only a small fraction of those who don't lose their money are lucrative. But this article does not seem to be well-focused nor well-supported.

    Try talking about trading stats - profit factor, Sharpe, Calmar and others. About risk of ruin. Etc. This is likely a strong reason for blowouts. They think they are profitable, but instead are Hold&Hope or Averaging down. And many of them ARE "systematic" But they constantly subvert their plan when exposed to large positions.
  3. Trend Following

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    Why is Sharpe relevant to systematic trend followers?

    Which blowouts?

    Who is averaging down?

    Who is constantly subverting their plan?

    What are you talking about?
  4. Sheesh. It was your article. I did not think you hired a ghost writer...

    Here is a link for "English as a Second Language"

    here is a book so you can converse on ET


  5. Systematic ?

    Does that mean 100 % automated ?

    The turtles were trained so that means that despite the rules they were given , there was place for discretionary input.

    How do you quantify "systematic traders" ?
  6. Trend Following

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    I know there are some very accomplished people lurking here, but clearly there are some real losers too.
  7. Trend Following

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    For example, the most successful Turtle Jerry Parker describes himself this way.

  8. Are all the Turtles 100 % automated ?
  9. Trend Following

    Trend Following Sponsor

    Clearly not. Chapter 12 of my book "The Complete TurtleTrader" lays out a "Turtle" who deviated and imploded. The ones with mechanical systems, automated systems, have survived and thrived. You can see that across all trend followers over the years.
  10. Why then were the Turtles trained when the system is supposed to be 100 % automated ?

    How can you teach an automated system ? You just give someone the code of your 100 % automated system and let it ?
    #10     Aug 23, 2009