Models, backtesting and risk management

This unrolled thread was very interesting to me. It’s about having a model, and backtesting it, to make your trading better. It’s by @EffMktHype. His very twitter handle shows that he’s skeptical of the Efficient Market Hypothesis (EMH). I’m a huge believer in the EMH. It’s not the ‘evidence’ that nearly all asset managers fail to beat the market. It’s that if someone had a consistently winning strategy they’d end up owning the market, and it would stop working. So, all the talk about models and back testing left me cold. It was like reading about the alchemists searching for the technique to turn base metal into gold. Physics shows this is not possible (except in a nuclear reactor). But, I can believe that a systematic way to close positions before losses get out of hand would be beneficial. Predictions are all very well. We all know that at some point the US dollar is going to cease being the world’s reserve currency of choice. This knowledge does not confer an edge, because the timing is so uncertain, as is the market reaction to this outcome becoming more imminent. Anyway, we need to keep an open mind, and this thread points out how one person understands what ‘having a system’ actually involves. I’d like to see some examples, but typically enthusiasts for systems won’t share them, even the ones that have been back tested to destruction.

Ten years of outsize returns

This [great summary by Charlie Bilello] is well worth studying. Over the last decade there has been:

• a mind boggling run by Bitcoin,
• a stonking run by NDX,
• a huge outperformance of growth over value styles,
• an amazing return on long-dated treasuries,
• awful returns on cash (relative to just about every other asset),
• a terrible return to commodities (because of the collapse in the oil price in 2014/5).

Nobody knows for sure, but some of these bull markets maybe long in the tooth. Certainly, bonds have done well for forty years. Maybe next year will be different. With the dollar taking such a hammering, it would be wise not to bet against any dollar-denominated asset though (or hedge the dollar exposure).