Do Systems Die?

Mar. 5, 2014

I’ve heard over and over and over that every System dies.

I’ve read it, I’ve listened to it, and I’ve been asked about it. It almost seems common knowledge to believe that all Systems break down at some point. How frightening! To think that no matter what you choose, the market will eventually change and make it obsolete?

Yikes!

I have a feeling, though, that Warren Buffett might disagree. In his System, his favorite holding period for a financial instrument is “forever.” If his holding period is forever, I think that means he’s fairly certain that his System won’t become obsolete.

In addition, Joel Greenblatt, writer of The Little Book That Beats The Market, tested his Magic Formula System over 30 years of data and it was incredibly consistent. He hasn’t changed a thing in his method since his book came out and has even started a fund using his System’s principles.

And famous speculator Jesse Livermore once said, “The game does not change and neither does human nature.”

So do Systems stop working or are there timeless principles that will work forever? Can we find out?

A few posts ago, I took the USDJPY and re-optimized every month, trying to keep “in sync with the current market.” I did this for a nine month period. 

When I did that, I made an extra $123 of profit by constantly re-optimizing.

But I wanted to know what would happen over the long term.

When you do a big optimization over many years of data, those numbers remain viable for a pretty long time. That just makes sense. If you test data over many years and hundreds of trades, it’s likely that those probabilities will work into the near future. The mathematical guideline is that if you do a big test—over, say, ten years or more—those parameters should be good for about 230 days into the future.

So I took one of my big optimizations on the USDJPY that ended on December 31^st, 2011 and then moved the data forward 230 days. Then I did another big re-optimization on the new data set. After I got those new inputs, I moved the chart forward to today to see how the new optimization did compared to just leaving it “as-is” and not re-optimizing.

Here’s what I found.

From 8/18/12 through 3/5/14, the newly optimized USDJPY made $4,612 with a drawdown of -$1,208.

In the same time period, the as-is, untouched chart made $6,418 with a drawdown of  -$1,208.

Definitely more profit by doing nothing. And when you look at the all-important profit to drawdown ratio, you get:

Re-Optimized: 3.8 : 1

As-Is Original Chart: 5.3 : 1

By leaving the chart alone, you did much better.

I’m not done looking at the possibilities of re-optimization. There’s something very attractive about always being on top of current market conditions. 

But it appears that a System can stay relevant through all types of different markets and may not need to be touched at all after applying extensive, long-term testing.

Warren Buffett would tell you that value investing will work forever. Maybe Systems can too.

Disclaimer:
It should not be assumed that the methods, techniques, or indicators presented in these products will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these sites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, the publisher, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.