Why is Trading in the Current Environment So Hard?

Aug 21, 2008: 12:03 PM CST

If you’ve been frustrated by your trading results for any of the quarters this year, or for the year to date performance, you’re not alone.  Many hedge funds, institutions, mutual funds, retail (at home) traders, and almost the whole spectrum experienced underperformance at least at some point since the market turned in October 2007, so let’s look at a reason why that might be happening.

It’s worth mentioning again that Bill Miller, manager of the Legg Mason Value Trust (LMVTX), had one of the (if not the) most phenomenal track records of mutual fund managers of our time, beating the S&P 500 for 15 consecutive years (that clearly not an easy feat).  However, that same fund lost 35% from January to August of 2008 (when the S&P 500 was down 15%), and from the October 2007 peak, the fund has lost 43% while the S&P declined almost 19% – that’s phenomenal underperformance that has led to negative press and money flow from Legg Mason funds.

Other hedge funds, mostly leveraged on the sub-prime or financial sectors, have gone entirely out of business since 2007.

It seems easy to say, “Well, then Commodity Funds or managed futures accounts have outperformed the market thanks to oil’s dominance” but that’s not even the case either.  While T. Boone Pickens is one of the most well-known oil investors did have a commodity and stock/hedge fund that performed extremely well throughout most of 2008, in July alone, that same commodity fund lost 30% (in one month!) and his entire portfolio lost 10% (according to an article via HedgeFund.net).

These are just two examples of major name players who are suffering in this current market condition – think what’s happening to the number of funds and individual traders you don’t hear about.

I wanted to highlight recent research by Rob Hanna at Quantifiable Edges who addresses this question with objective and eye-opening research in his recent post “How to Trade the Choppiest Environment in 50 Years.

Hanna details various studies that use end of day entries, such that if today’s close is higher than yesterday’s close, buy the market and hold until there is a down day (today’s close is less than yesterday’s close).  You would expect that moves would carry over, such that strength begats strength (in terms of trend and swing trading) and you’d be 100% correct from 1993 until 2000, and then would have suffered losses along with the market through the 2001 – 2003 bear market, however pay very close attention to the right side of Hanna’s equity curve graph – notice how precipitously the strategy fails in the 2007-2008 current environment.

The same is true for all the scenarios he tests (including shorting down days and buying to cover on the first up day, and even combining these into a unified strategy).

Hanna concludes:

“As you can see, buying after strong days and selling after weak ones worked well for 40 years. In 2000 that changed, and the last year and a half is the worst it has ever been with regards to follow through. This would suggest that strategies that may have worked well for forty years or more could be suffering greatly now.”

On the same day, Dr. Steenbarger of TraderFeed addressed this same tendency, yet focused on international markets in his post Short-Term Reversal Patterns Among Global Equity Indexes. Steenbarger concludes:

“Across the globe, short-term trend following has been hazardous for traders’ wealth. Even longer-term traders need to take these reversal patterns into account, if only to size positions and set stops for expected heat.”

Capital preservation may be the #1 new goal in thisenvironment.

(“Derailed” image courtesy and copyright Narrative Photography)

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7 Comments

7 Responses to “Why is Trading in the Current Environment So Hard?”

  1. Anonymous Says:

    ““As you can see, buying after strong days and selling after weak ones worked well for 40 years. In 2000 that changed, and the last year and a half is the worst it has ever been with regards to follow through. ”

    got any stats on the opposite since 2000; selling after strong days and buying after weak ones?

  2. Corey Rosenbloom Says:

    Anon,

    This was a quote taken directly from Mr. Hanna. He provides various charts/graphs as to the results, but I did not conduct this study so I can only link to it, but it would be interesting to do a separate study to verify the results and add additional analysis.

  3. PW Says:

    Hey Cory,

    By any chance did he mention what method DOES work because I’m all ears. I’m getting killed in this market, but most of is my own fault. I had noticed that my system was not working anymore. This was a great article I’ll have to link to it shortly.

    PW

  4. Corey Rosenbloom Says:

    PW,

    Haha I wish! Actually, Rob did at the very end of the post (something I didn’t copy because I wanted readers to go visit his site and read the whole context) – Hanna states:

    “Buying weakness and selling strength is working better than buying strength and selling weakness. They could also monitor charts like these to see if tendencies begin to revert back to pre-2000. If tendencies do revert, adjustments may be needed.”

    Which is logical – if the old “buy strength, sell weakness” mantra doesn’t work, flip it. Buy Weakness, Sell Strength. Perhaps that’s where the edge is but it so counterintuitive that it almost hurts, but it just might work.

    Just look at the DIA chart I posted as a small window. How many red bars were directly followed by white bars? More than make us comfortable.

  5. Woodshedder Says:

    I’ve just completed a study which does not disprove Rob’s study, if you want to check it out.

  6. Ideas to Finish Off the Market Week | Forex Hour to Hour - Forex Trading News, Forex System Reviews, Twitter Updates Says:

    [...] * Tough Trading – Quantifiable Edges looks at the challenges of trading a choppy market environment; see the commentary also from Afraid to Trade. [...]

  7. Lukesh Says:

    I don’t think trading is that hard but we just complicate it too much into our heads and think about stuff that has really not much relation with reality. If we don’t think too much and keep trading simple we would be able to get brilliant results. I trade with OctaFX broker and it has lovely system with having low spread of just 0.2 pips, high leverage up to 1.500 so that really makes life very simple and easy for me.