It’s Not The Strategy. It’s You.

The other day I did a very simple Excel sort on a whim. I downloaded the last ten years of monthly closing prices for the euro and made a simple rule -- buy when there were three months of consecutive declines and sell when there were three months of consecutive rises. Then I liquidated the month following.

Now given that the euro is essentially a bounded product (unlike equities, commodities cannot rise upwards forever) you would think that this simple mean reversion algo would work. Surprisingly, the results were horrid. The strategy lost more than 1500 pips over the past 10 years as the highs kept getting higher and lows lower.

The only time this strategy worked well was in the the last three years when we have had record low volatility and selling highs and buying lows has been the recipe for riches. As counterintuitive as it is to imagine, momentum is the superior way to trade in FX over the long run even though in the present market environment it can be a massive challenge.

Which brings me to my real point today. It’s not the strategy. It’s you. There are only two ways to trade markets -- momentum or mean reversion, and frankly it really doesn’t matter which strategy you choose. The best momentum algo will get chopped in range and the best mean reversion strategy will wipe out your account in a strong trend.

The key is to success is adjustment and adaptation. There is no strategy that will work consistently all the time. Some of the smartest traders in the world often make the mistake of arrogance in assuming that they have figured out the markets when in reality they were simply using a strategy that was in sync with the market at the time. Witness John Paulson, witness Long Term Capital Management, witness Bill Miller and countless other investment “geniuses” who blew up the moment the market changed.

At BK perhaps our best quality is that we don’t stay arrogant for long. Last quarter, the record low vol decimated our strategy with the worst return of our career. Instead of repeating the same mistakes, we made adjustments -- in all honesty we should have made changes much sooner -- but we are human and hubris is the permanent enemy of the trader.

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In any event, the interesting thing is that we did not change our style in order to follow the latest vagaries of the market. We remained momentum traders but we made several key adjustments to adapt to the current low volatility environment. The net result was 1300 plus pip swing in performance our way, proving once again that in trading it is not the strategy, it’s you that is the key to success.

Boris Schlossberg

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