In theory, it makes perfect sense that fundamental changes in markets over time could cause systems that had an edge to become unprofitable. However, because we generally backtest systems all the way up to the current time, encountering a system with a dramatic change like this is not common.
Matt from Don’t Fear The Bear recently came across a system that gave him the opportunity to test two different time periods. The system he discovered was written and backtested in 2009. At that point everything looked great, but as you will see that did not continue to be the case. Matt was able to replicate the previous backtesting results testing over the previous time period, but the results moving forward were drastically different.
Matt shows us a system that performed one way up through 2009 and has produced inverse results ever since.
Here is how Matt came across those posts:
I was browsing my twitter feed this week and saw a couple old Quantifiable Edges posts (hereand here) linked to by @PsychTrader.
The two posts were written in mid-2009 and detail a simple weekly strategy that uses the relative performance of the S&P 500 and Nasdaq indexes to time the market.
They showed how investing in the SP 500 or Nasdaq when Nasdaq has been outperforming (based on 10 week relative performance) has generally beat out buy and hold.
Matt decided to test how a simple system that held either QQQ or cash depending on whether QQQ was either outperforming or underperforming the SPY would fare. He tested two different versions. The first version held QQQ when it was outperforming the SPY and cash when it was not. The second version held QQQ when it was underperforming the SPY and cash when it was not.
Here is what Matt found:
First let’s look at the period from 1999 (inception of QQQ) to the end of 2008.
The strategy to invest in QQQ when it underperformed SPY got crushed during the bear markets and just treaded water during the bull market.
The inverse strategy did much better and held its ground through bull and bear period alike.
Interestingly, the strategies flip-flopped starting in 2009:
The strategy that sucked big time before has been steadily rocketing higher while the formerly better strategy has been treading water.
I guess this is just another example of strategies being turned on their head at the market’s whim. This is one I’ll be keeping tabs on going forward.
As you can see, this weekly QQQ strategy makes logical sense and would be fairly easy to trade. The only problem is that you wouldn’t know which version to trade moving forward. This further stresses the point that backtesting results do not guarantee future performance!
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