I blather a lot about circuit breakers and I’m sure many of you wonder why I talk about them so much. To tell you the truth I had even started to ponder that myself. Just the other day I was talking to my marketing contractor Eric Wolf about the S&P 500 Margin portfolio because I had invoked the CB. He said he wanted to trade through in order to and be on board when the equity curve moved back up. He has a lot of confidence in these portfolios, as do I, and knew it would come back. I started to look at the CB with a skeptical eye and thought I should do an analysis to see if indeed my viewpoint was incorrect. As soon as I looked over some of the strategies I have disabled, I renewed my position that a CB is necessary.
Once we get done here I bet you’ll all agree this safety net is invaluable and that you should never trade without it.
Systems fall in and out of sync with the market
Howard Bandy is known for his stance on the market, “Systems fall in and out of sync with the market.” and when they fall out of sync you have to take the necessary steps to ensure you don’t go down with the ship. I’m sure there are many ways you could go about this but the first step would be to identify what “out of sync” means. As you know I like to quantify everything I trade so I would need to see the evidence the strategy I am trading is no longer aligned with the market.
And then what do you do? It’s not good enough to just identify a condition but you have to do something about it when it’s encountered
When I started QiT, I had two mean reversion systems then added momentum portfolios throughout the years. Over the last 12 months, I’ve disabled the two original mean reversion strategies and now only have momentum. It is obvious what is working and what is not, and that mean reversion is out of sync with the market whereas momentum is not.
But the $64000 question is how do you know when the strategy you are pouring your well-earned funds into is out of alignment and you’re not just experiencing a Plain Jane (only I’m allowed to say that) drawdown (as if any drawdowns are plain)
My answer to this is, “you don’t know and furthermore, you don’t care” It’s possible you will never know so you step aside until you see conditions change.
This is what the CB does. If an equity curve falls under its CB we move to the sidelines until the strategy proves to us it is still valid and is not jibbing while the market is jabbing. If it does not get back in alignment, it doesn’t matter because we are in cash and not trading it.
It’s really as simple as that.
L1-AM Margin Mean Reversion
To illustrate my point, here’s the Equity Curve of what some of older members remember as L1-AM up until November 2015
This is a pretty darn good looking equity curve as far as I can see. Little did I know that the days of mean reversion were numbered. The equity curve fell under its circuit breaker and I took it off line. I did bring it back once but quickly realized it was too soon.
Here’s what happened.
This strategy fell under its CB and has not recovered. If you had wanted to trade until it came back you’d still be waiting and might I add, hurting. What I wasn’t willing to do was fight the tape and I disabled this strategy.
L1-RP Retirement Mean Reversion
Let’s look at the L1-RP, the retirement mean reversion.
As you can see this one was not as quite as clear as the Margin Mean Reversion and did have a very nice run earlier this year but looking back on this equity curve you’d have to admit, since the beginning of 2015, the curve doesn’t have the same look as it did since 2010, It was mostly flat for the most of 2015 and except for the very nice climb beginning in January 2016, it returned to flat and is now back below the CB again.
Knowing the Margin Mean Reversion was going to be disabled I just couldn’t in all conscientious bring this back
Interestingly, I received an email from a new user, Bill, earlier this week. His question was, “If the equity curve moves below the trigger MA, will we sit for months with no signals until it moves back above? I’m wondering what it might feel like to be paying for the service month after month until signals start again..
As you can see from the examples above, we never know when or if a portfolio will return above its circuit breaker. That’s why there are six portfolios to choose from. If one is out of sync with the market, then you can choose to either wait it out or move your money to another portfolio. Unlike other services, Quantitrader doesn’t try to force trades for the sake of trading. So the question I would ask is would you rather have a service that keeps you in cash when conditions are not optimal or a service that keeps incurring losses month after month and charging you for that privilege?