EOFY Review

In the first quarter of last year I begin to tinker with my short term system – in fact the tinkering was so extreme that it essentially became a brand new system. Fortunately, this tinkering coincided with a the onset of a new financial year so I have a full year of data to review the results of these changes. The prime metric I use for deciding on how a system is going is the unit price which I plot on a regular basis – plotting the unit price removes the need for ugly calculations involving the addition and subtraction of capital. Unfortunately, some traders go overboard with their metrics when all you need to know as a first principal is whether you made money or not. Once you have cleared that hurdle you can begin to delve deeper but not too deep because for some reviewing the metrics of their system becomes more important than the system itself.

This is actually the second review of the system I have conducted. I conducted a review about half was through the financial year after the conclusion of some trades and he reasons for that will become apparent when you see the equity curve. This system was redesigned with a simple aim in mind (hence the simple metric) to make money. That sounds somewhat obvious but often when you design a system you do so with an understanding that the volatility in your returns is a function of the aims of the system. For example, longer term equity systems are designed around the notion of reasonably low volatility ans the capacity to ride trends often for several year. In contrast to this a system that was based around option writing would look for much shorter term trades and would seek to reduce volatility within a system. Unfortunately, this is not generally what happens to option writers as they become enamoured with the notion of free money and they blow themselves up. As the saying goes option writers eat like birds but shit like elephants.

The equity curve below shows what happened during the year.

Unfortunately when people see this sort of equity curve they are immediately drawn to the acceleration that occurred in December and in doing so they neglect that fact that system had a 50% drawdown in June which was followed by a recovery and then another 50% drawdown. I had actually expected this to occur because the system is heavily geared. Remember this is a damn the torpedo’s, full speed ahead style of system. With the level of gearing involved it was inevitable that the system would have some hellish drawdowns as this has been my experience in the past.

I said that this is actually the second review of the system I have undertaken. The first occurred after the run up in December, after such events I tend to review the trades that generated this sort of event and see if there is anything additional that could be learned from them – there generally is. My aim in the second half of the year after the review was to simplify the system even further – this meant that the archetypes driving the entries had to modified and tightened up. However, the mid point review of the system reinforced in me a few points that I think are key to not only trading this sort of system but any other.

1. The returns come from a handful of correctly managed trades. In this instance the bulk of this tun came from a single trade. I am wrong a lot but that doesn’t worry me because my ego is not tied to being right.
2. Money management is paramount – I run away at the first sign of trouble.
3. Intriguingly irrespective of the style of system most returns come from a very small number of trades. You just have to learnt o deal with this.
4. There is an awful feedback loop in trading. If you survive long enough you make money, the more money you make the longer you survive…..and so on. Most people dont survive long enough to get any traction.
5. It requires patience – you can go a long time between drinks but if you stop steeping up to play then you have no chance of ever winning.
6. Drawdown is part of the game when you are leveraged. It is also part of the game when you are not leveraged.
7. It takes courage – this system fluked an early upswing in the equity curve and then went nowhere for six months during which time I still took every trade and racked up some decent losing sequences. And then it stopped losing money and took off and that is my expectation for this coming year as well. If yo cant handle the drawdown then you shouldn’t be playing with these sorts of systems.
8. The market will let you facilitate whatever you want if you manage to work out what you want and then take the time to design an approach to make it happen.