Download the rules to a trading system that makes 170% a year in stocks.
Regular readers of this blog will be aware that I like to create trading systems using Amibroker; a program which allows you to test various investment strategies on historical stock data.
In my opinion, trading systems are extremely valuable because they let you trade without emotion. Today I have come across a strategy that is simple yet incredibly powerful and if you keep reading you will discover the rules to these amazing trading system.
Beating Warren Buffett
I’m sure you will agree that the Sage of Omaha, Warren Buffett, is one of the greatest investors of all time.
Over the last fifty or so years, Buffett has returned around 20% annually, making him one of the richest men in the world with a total wealth of over $60 billion.
But what if you were able to make much better returns than 20%? What if you could come up with an algorithm that makes 170%, or even more?
With a compounded annual return of 170% you would kick Warren Buffett’s butt. You would destroy Jim Simons, thrash George Soros and wallop Bill Ackman. Starting with just $10,000 you’d have $100 million in six years and a billion in less than 10.
The 170% Per Year Trading System
This trading system has been designed for use on the S&P 500 universe of stocks. It is long only (meaning that we will only buy stocks, never go short) and it’s made up of very simple rules.
It’s just a simple trend following strategy that buys a stock when a quick moving average crosses above a slower moving average. So when we see a stock with a moving average crossover, we will buy it, let the trend run for a profit, then sell as soon as the trend is over.
Using Amibroker I have tested this system on the S&P 500 universe of stocks between 2000 and 2012. As you can see from the results below, this simple strategy has performed incredibly well.
Between 2000 and 2012, the trading system produced an annualised return of 172.45% with a drawdown of 14%. That gives it a CAR/MDD of 12.34.
It also has a Sharpe Ratio of 3.91 and a Profit Factor of 9.29. This is a truly remarkable result that has the potential to make you the richest person in the world in just a few years!
As you can see from the equity charts and the monthly table of results, this trading system produces amazing returns in the US stock market.
Starting with a capital of $10,000 the system has ended up with more than $1.6 billion in just 12 years. At this rate. you will be richer than Buffett in no time. You could even become the very first trillionaire.
So, what exactly are the rules to this system?
//Start System Code
SetFormulaName("APRIL FOOLS");
SetOption( "InitialEquity", 10000);
PositionSize = -100;
Buy = Cross(EMA(C,2),EMA(C,5));
Sell = Cross(EMA(C,5),EMA(C,2));
BuyPrice = O;
ClosePrice = O;
//End
Unfortunately, the April Fools trading system is an unrealistic trading strategy.
The trading results and equity curves are real and were produced in Amibroker. However, the system code was designed in such a way that the results cannot be relied upon.
There are at least five major flaws with this system.
1. Curve-fitting
First of all, the trading system has been curve-fit to the existing data. The parameters for the moving average crossover were optimised to find the values that lead to the strongest performance in the test period. If we were to use these parameters going forward, there is a strong chance that they would not perform as well.
2. Future leak
Second, this system actually looks into the future. On line five (above) we have instructed Amibroker to buy a stock when the 2-day EMA crosses over the 5-day EMA. However, this EMA (exponential moving average) is calculated using the close price and Amibroker is actually buying the stock using the open price (line seven). In other words, we are buying the stock before the EMA crossover takes place, knowing that it will happen later on. This is clearly not possible.
3. Zero commissions
Thirdly, this system uses no commissions or slippage. In real life, it costs money every time you make a trade . You are also not guaranteed to get filled at the price you want, especially for large orders. Having no commission or slippage is not realistic and can make a big difference to simulation results, even more so when trading on short-term timeframes.
4. Survivorship-bias
Fourth, this system suffers from survivorship-bias. The system buys stocks from the S&P 500 universe, however, in this instance we have not included historical constituents or delisted stocks. This means our results are a victim of survivorship-bias.
In real life, businesses go bankrupt, they get taken off the exchange, some merge with other companies. These changes are not always reflected properly in historical databases. Thus, it’s always important to use data that is survivorship-bias free. Such data can be obtained from Norgate Premium Data and easily accessed in the Alpha program.
5. Liquidity
Lastly, the system relies on unrealistic liquidity. When you buy a stock in real life, your position size and entry price will be dictated by how many shares there are available to purchase at the time, also referred to as volume. Normally, you would not want to purchase more than five or ten percent of the total volume as any more would than that would suck up the order book and move the share price not in your favour. This system has a limit of 50%, meaning, it’s able to buy up half the day’s volume without any movement to the buy price. This is unrealistic.
Running the System Again
Now we know what are the major flaws with this trading system we can fix them up, move the dates forward and run the system again using unbiased out-of-sample data between 2012 and 2016.
Following are the results:
Incredibly, the trading system actually made money in the out-of-sample test even though the rules were data mined. However, as expected it achieved nowhere near the same performance level.
The truth is that you will never find a trading system that makes 170% a year. Even though thousands of traders every year are duped into buying one.
So, sorry to build your hopes up with the dream of a 170% per year trading system. But I hope you have at least learnt some things to look out for when building or analysing a trading system.
I know you didn’t fool for it anyway 😉
Forex Trader Specialist
John, David and Alexandra have worked on Wall Street for a combined 35 years, trading for huge firms like (now defunct) Lehman Brothers and Goldman Sachs trading the markets on behalf of high net worth individuals. After thousands of trades and hundreds of trading accounts, they are here to share the fruit of their work and knowledge with other traders. The trio divide their time between New York and London.
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