Since the last report on the top 10 trading systems in the February 2006 issue, systematic traders have suffered through one of the most difficult periods in many years. These non-system-friendly markets have been around for nearly three years now and there is no indication they will end soon.
If they shift back to normality soon, however, 2006 will have marked a nadir. All systems, not just a particular style, suffered. The trend followers, hungry for a trend, have been enticed into choppy markets by several false breakouts, or they didn’t react quickly enough and paper profits eroded.
On the other end of the spectrum, stock-index day traders have underperformed due to the loss of market volatility. Without market movement, day traders cannot make enough to cover transaction costs. The once wildly popular E-mini S&P 500 has continued to drop out of favor with systematic day traders and has, at least among this trader demographic, been replaced in portfolios with the E-Mini Russell or E-Mini S&P 400 (Midcap).
It’s no surprise that the top 10 trading system have not been spared. The majority of the systems in this list have either experienced their worst drawdowns or have come pretty close in this market.
ISLANDS OF PROFITABILITY
While many systems suffered in 2006, the year was not completely bleak. A handful of markets came to life and helped buoy the performance numbers of systems and commodity trading advisors (CTA) alike.
Copper was the big mover early in the year with a surge from $1.98 to $4.04 per lb. Unfortunately, this stratospheric leap was followed by a quick 25%-plus retracement and then a congestive phase. The usual trend following staples, currencies and financials, traded in a very wide trading band, which provided profit and loss potential. The energy sector and sugar, like the metals, exhibited either all-time highs or multi-year highs, followed by major retracements.
The long-only traders and CTAs have suffered worse than those who play both sides of the market. The performance of long-only commodity indexes is an example of what can happen when you commit to a long-only bias. Corrections in the energy and metals hurt their performance.
SMALL CHANGES
With the pain spread around evenly, it should be little surprise that the list of the top 10 systems has only had one modification in the past 12 months. R-Mesa 3 was replaced with the portfolio trading Andromeda. R-Mesa 3 is still a good system, but the performance of Andromeda could not be overlooked. All these systems have been around for a number of years and have done well throughout the long term.
Performance for most of the systems is shown from January 1986 through November 2006. The portfolio trading systems were tested on the following markets: U.S. Treasury bonds, T-notes, British pound, Japanese yen, Swiss franc, euro (or the Deutsche mark as a historical proxy), soybeans, cotton, live cattle, copper, sugar, orange juice, heating oil, crude oil, natural gas and silver.
Two systems, R-Breaker and Stafford STC, were solely tested on the S&P 500 because they are day trading systems. Two other systems, Dollar Trader and Trendchannel, were tested on much smaller portfolios. A $100 charge was levied per round-turn trade on the day trading systems and $75 was levied for all other systems, also on a round-turn basis.
DON’T DOUBT IT
After seeing these system results, most reasonable traders would scratch their heads and ask, “Why would I want to trade any mechanical system?”
Consider, however, that a mechanical trading system affords the ability to trade in a purely nondiscretionary manner. Without systems, you would have to trade using discretion and that is an approach that prevents historical backtesting. With systems, you can have a gauge on future performance. An effective trading plan can only be built around reasonable expectations and these expectations can only be formulated through
historical backtesting.
Even though these systems have shown poor performance for the past two or three years, they have shown positive performance for more than two decades. Unless trends become completely extinct, these systems should perform into the future and provide a solid foundation for any trading plan.
While in light of recent performance, system traders, portfolio managers and CTAs may need to realign their expectations, the positives of a fully systematic approach still outweigh the negatives.
You can view Pruitt’s previous top 10 systems features at www.futuresmag.com/previoustopten.
George Pruitt is director of research of Futures Truth magazine and co-author of Building Winning Trading Systems with TradeStation and The Ultimate Trading Guide. George can be reached at george@futurestruth.com or www.futurestruth.com.
