There are hundreds of automated trading systems that tout strong positive returns. Some of these systems present “live” track records while others present only “hypothetical” performance results. The question any potential subscriber might ask is whether a live track record may be better than a hypothetical one.
It’s true that systems with live track records have proven their trading thesis in the live markets. And if their performance was positive, then that says a lot about a given trading system. But it isn’t always the case that an algorithmic system will continue to perform well in the future. That’s where speculation comes into play. It’s also why almost every system comes with the common disclosure that “past performance doesn’t necessarily indicate future results.”
Here are a few things to think about when considering subscribing to an automated system whose performance results are based solely on hypothetical trades.
No Proof in the Pudding Can Mean a Total Speculation
Despite a system’s back tests, there’s no way to determine whether the system developer’s trading concept will produce similar results once it hits a live market.
What to do: pay attention to the system’s expected profit factor, average drawdown, and worst historical drawdown. If the system’s live performance comes close to matching its hypothetical performance, then the system’s results should stay within its performance parameters over time.
All Successful Systems Began as a Hypothetically-Tested Product
If you come across systems that have strong live performance results, remember that those systems once had only hypothetical results. When “robust” systems begin breaking down, it’s usually due to changes in the macroeconomic environment. If the developer is agile enough to tweak the system’s trading rules and parameters, then the system may continue to perform well. If not, the system begins to fail.
But once a “tweak” has been made, note that they system is once again in “hypothetical” territory, as its following new rules that have not been tested in a live market. Aside from this, there’s nothing to say whether a new system will or will not work in a live market despite its back tests.
Does the Concept Make Sense?
Not all automated trading systems are “black boxes,” where its strategy or methodology is concealed from the subscriber. If you can get information on a system’s strategy, and if it makes sense, then it might be worth testing in the live market.
Day Trading Strategies May Succeed or Fail Faster
Day trading strategies tend to place several trades intraday. If their profit targets are small–say, a few points or ticks–then are often more exposed to the risk of not getting filled on every trade or experiencing a great degree of slippage (which can erode from profit or worsen a loss).
The good thing about shorter-term systems is that they tend to show their strengths or weaknesses faster. If they happen to be on the losing side, all you need to do is check their live performance against their historical performance parameters (e.g. profit factor, average drawdown, etc,). Making this comparison might tell you immediately whether the system is all “promise” or whether it can produce real profits.
System Diversification May Be As Important As Market Diversification
Here’s a common diversification mistake that many automated system subscribers make: pleased with the results they’re getting from Developer X’s crude oil swing trading system, they then subscribe to Developer X’s gold swing trading system and Nasdaq swing trading system.
Sure, they’re diversifying their markets. But they’re not diversifying their time frames, trading strategies, and developers. The goal of system diversification is to trade systems that are not subject to the same economic or market factors, time frames, and strategies.
Trading an automated system that has only a hypothetical track record presents risks and opportunities. It may fail (hopefully sooner rather than later) or it may end up proving itself to be fairly robust. If you’re willing to be one a system’s “first adopters,” then make sure that your system’s underlying strategy makes sense, monitor the system’s live performance relative to its hypothetical stats, and definitely consider diversifying your portfolio so that you don’t have everything riding on just one system.
Please be aware that the content of this blog is based upon the opinions and research of GFF Brokers and its staff and should not be treated as trade recommendations. There is a substantial risk of loss in trading futures, options and forex. Past performance is not necessarily indicative of future results.
HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM.
ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.