Why Robust Trading Strategies are more Volatile
Excerpt from a great paper written by Dr. David Druz
Volatility, Robustness, & Longterm Performance of Futures Trading Systems
The information in this paper is entirely my opinion. It is based on many years of experience in systems research, not on one particular study or another. I am unable to provide specific documentation for opinions formed in this manner from experience. To the best of my knowledge and belief, however, the opinions expressed herein have reasonable basis in fact. I am often asked, "Why is your Tactical system of futures trading volatile?" Robustness and increased odds for survival have a lot to do with it. But I am getting ahead of myself... Most investment administrators recognize that the relative volatility of any component investment in a portfolio is unimportant in itself as long as the investment is uncorrelated with the portfolio's other assets and improves the performance characteristics of the portfolio as a whole. Yet many still find it difficult to actually invest in a potentially beneficial yet volatile instrument. This paper explains why I believe volatility should never be a concern with a Tactical commodity and currency futures investment and, in fact, why volatility is to be expected when we are doing things right! The rationale for futures systems trading The Tactical method is a "systematic," as opposed to a "discretionary," approach to futures trading, and the opinions expressed in this paper apply to systems trading, not discretionary trading. In a systems approach, all trading decisions are made by following algorithms that are specified exactly and are followed precisely. Decisions are totally unemotional and may therefore be established in every case on statistically validated trading principles. Systems trading works because futures markets are not efficient in the classical sense: price movements ("trends") that are mathematically distinguishable from unprofitable random behavior occur with significantly greater than chance frequency. This deviation of futures markets from mathematical efficiency was addressed as early as the 1960’s by papers in the Journal of Finance, yet astonishingly continues to be ignored by much of the academic community, perhaps because academics are more familiar with stocks which indeed behave more randomly. Why futures behave as they do is beyond the scope of this paper. There are, however, whole families of quantifiable systems that can be shown to be profitable in futures markets. If this is a shock to any academic types, my apology. Of consolation perhaps, systems trading is by no means a free lunch, as I will explain. What you should know about systems trading Systems lend themselves to computerization and rigorous historical testing. For over 20 years I have examined hundreds of types of systems, across multiple variable parameters, analyzing literally tens of thousands of systems. These four conclusions about futures systems trading have been overwhelmingly supported by my research:
The majority of futures trading systems do not hold up over time.

Stable trading systems tend to be longer term in nature.

For a system to succeed, it must be followed religiously.

The robustness of a trading system is proportional to its volatility.
For a system to have the highest odds of profitability over time and markets, the inescapable tradeoff is volatility. Diversification is used of course, but it will only dampen the volatility so much.NOTE THAT PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS AND THAT FUTURES TRADING ENTAILS RISK OF LOSS.
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