Don’t Judge Long-Term Systems On Short-Term Results

It takes time!

long-term systemsOne of the most common mistakes made by system traders is getting discouraged with the short-term results of a long-term system. Depending on the arbitrary starting and ending points for a given system, even the best systems will underperform at certain times. It is important to remember to think with a long-term perspective and trust your system to do its job.

This has become very clear in the performance of most of these simple systems. None of them have performed up to expectations over the past few months, but that could have been anticipated based on the fact that we started following them when the SPY was right at an all-time high.

We can also see this coming into play with regard to the systems that have short components. Almost all of them got caught with their pants down holding short positions on the day that the Fed announced that they would continue printing money. That one huge up day stopped all of the systems out of their short positions at big losses. Ironically, the market has trended down ever since that day.

Every trading system will have months where it outperforms other systems and months where it underperforms other systems. Our job as system traders is to maintain focus on how we expected the system to perform in a given environment.

Comparing Our Systems

long-term systemsSystem 2B continues to lead the way this week with a meager 0.62% overall return. While this is a pretty lame return for the past few months, the system has still outperformed a buy and hold approach because it was able to sit in cash while the general market corrected in early September. Of course, we are still dealing with ridiculously small sample sizes here, so the returns to this point really don’t mean much.

What is interesting to note is how hard it would be if you began trading any of these strategies in mid-July. There is definitely something to be said for the importance arbitrary start and end points can have on returns.

The big winner this week was System 5, which booked another small profit on a quick trade. Because it is a mean reversion system, it is far less correlated to the general market and is thus able to make gains while the longer-term trend following systems stand pat. System 5 was able to move slightly ahead of all of those longer term systems and now ranks second behind System 2B.

System 4 has continued to have the worst luck out of any of the systems with timing its entries and exits. It was correct on many of the trends it has identified, but it missed out on a couple of big days and was exposed on a couple of bad days and that has made a significant difference.

The systems with short components continued to wallow in the holes that they have dug for themselves. They are all going to have a hard time coming back from the losses that they have already posted.

System 1 – Buy & Hold

Overall Return: +0.44%

Last Week: +0.47%

long-term systemsWhat felt like a roller coaster ride throughout much of the week turned out to be not much of a big deal after all for System 1. At the end of all of the week’s ups and downs, the overall return was in almost exactly the same place that it started.

After the big rally on the day of the Fed announcement a few weeks ago, the market has really sputtered out. There have been more down days than up days by a wide margin, and the down days have been coming in more significant volume.

Despite those ominous warning signs, System 1 is going to hold strong because that is what System 1 does. Buy and hold investors expect that the market will always move higher over the long run, so they simple hold on hoping that they don’t need their capital during one of the many major drawdowns. Since there are no trades to be made in System 1, its investors will spend next week hoping for more Fed assistance and higher prices.

System 2 – IBD Market Calls

Overall Return: A: -1.36%, B: +0.62%, C: -3.56%, D: -1.21%

Last Week: A: -1.32%, B: +0.65%, C: -3.53%, D: -1.17%

Here is a quick reminder about the different versions of System 2:

  • System 2A – Long on Confirmed Uptrend, Cash on Market In Correction
  • System 2B – Long on Confirmed Uptrend, Cash on Uptrend Under Pressure
  • System 2C – Long on Confirmed Uptrend, Short on Market In Correction
  • System 2D – Long on Confirmed Uptrend, Cash on Uptrend Under Pressure, Short on Market In Correction

long-term systemsAs the distribution days continue to pile up, Thursday’s negative price action cause IBD to shift its market outlook to Uptrend Under Pressure. This signaled Systems 2B and 2D to exit their long positions at Friday’s closing price. Obviously this didn’t have an impact on this week’s returns, but it will further differentiate the systems starting next week.

With distribution day counts of 6 for the S&P 500 and 4 on the Nasdaq, things are not looking good for the overall market from IBD’s perspective. Any more negative action will likely cause them to move their outlook to Market in Correction. This would cause Systems 2A and 2C to exit their long positions as well. It would also signal Systems 2C and 2D to enter short positions.

The last time those systems entered short positions they got caught in those positions on the day of the big Fed announcement. Another short opportunity could give them a chance to demonstrate the potential profits a short component could add. However, it is also very possible for them to get squeezed again and dig their holed even deeper.

System 3 – 10/100 Moving Average Crossover System

Overall Return: +0.43%

Last Week: +0.47%

long-term systemsSystem 3 didn’t regain its 10-day line this week, but things didn’t get much worse for it either. Continuing to trade below its 10-day line has begun to pull that line down towards the 100-day line. However, there is still a good bit of room before the system generates a sell signal.

While the results have not exactly been expiring for System 3 thus far, it has certainly done what it is designed to do. Although there hasn’t been much forward progress in terms of price action over the past few months, the long-term trend direction is clearly still upward. System 3 has never wavered in its stance that the long-term trend direction is up.

It is important to keep in mind that if we had started trading this system before the entry signal for this current trend we would be sitting on a healthy profit at this point. If that were the case, it would be much easier to tolerate the choppy market we have been watching for the past few months.

System 4 – 89/13 Breakout System

Overall Return: -4.14%

Last Week: -4.10%

long-term systemsThis was a very exciting week for anyone trading System 4. The SPY broke below its 13-day low on Monday, but was able to rally back and close just slightly above the line. It broke below that line again on Thursday, but again was able to rally back to close above it.

The path of least resistance seems to be to the down side right now as the price continues to trade below its 13-day moving average. As time continues, the possibility of closing below the 13-day low and signaling an exit becomes more and more likely. There appears to be a strong chance that System 4 moves back into cash in the coming week.

System 5 – 3 Day High/Low Mean Reversion System

Overall Return: +0.58%

Last Week: +0.44%

long-term systemsSystem 5 was the one system that did benefit from the volatility this week. After almost getting an exit signal last week that would have generated a loss, the SPY finally closed above its 5-day moving average line on Tuesday. That signaled System 5 to exit its position at Wednesday’s closing price. This notched one more small gain for the system.

Friday’s big up day reset the count for down days in a row, so System 5 is coming into the new week with a clean slate. If the price closes down with lower highs and lower lows for three days in a row this week and it is below the 5-day line, the system will enter on the following day’s close. If that doesn’t happen, it will simply sit on the sidelines and watch.

System 6 – Simple Moving Average Systems

Overall Return: A: +0.44%, B: +0.44%, C: -3.10%, D: +0.44%, E: +0.44%, F: -6.57%

Last Week: A: +0.47%, B: +0.47%, C: -3.07%, D: +0.47%, E: +0.47%, F: -6.53%

Here is a quick reminder about the different versions of System 6:

  • System 6A – Long above 200 day SMA, Cash below 200 day SMA
  • System 6B – Long above 100 day SMA, Cash below 100 day SMA
  • System 6C – Long above 50 day SMA, Cash below 50 day SMA
  • System 6D – Long above 200 day SMA, Short below 200 day SMA
  • System 6E – Long above 100 day SMA, Short below 100 day SMA
  • System 6F – Long above 50 day SMA, Short below 50 day SMA

long-term systemsEach of the six versions of System 6 came into the week with long positions, and those positions held up throughout the week. It did get close for the versions that trade based on the 50-day line. The SPY broke beneath that line on Monday and Thursday, but managed to close back above it on both days.

Unless we see some major selling in the coming week, the 100- and 200-day moving averages are not likely to be in jeopardy. The 50-day line could go either way depending on the coming week’s price action.

It is worth noting once again that the short-term 50-day line has not been a good trading signal to this point. Going short when the price breaks below the 50-day has fared even worse over the past few months. So far, it appears that long-term long-only versions of these systems are the best performers. However, that could all change if we find ourselves in the middle of a long-term bear market.