Nearly everyone who has been around the London Stock Market for any period of time will have heard of the age-old saying "Sell in May, go away, don't come back until St Leger's Day". I suspect that religious types may rush to point out that St Leger is the patron saint of some lost cause or another but, in the context of this article, it refers to the four day horse racing festival which takes place at Doncaster racecourse every September culminating in the world's oldest Classic, The St Leger Stakes.
So what does this age-old saying actually mean?
The inference is that there is no point trading in the summer. All the brokers and fund managers will be hanging out on the beach, or attending Wimbledon and Ascot. Volumes will be low and markets more likely to fall. Once the racing season's over, the City boys get back to their desks...and the stock market picks up.
Nowadays, a large section of the City considers this complete nonsense. There's a "harder working culture to the City" than there used to be, insists Hilary Cook of Barclays Stockbrokers. Selling in May and buying back in September is an "eccentric form of market timing", agreed David Kuo on Motleyfool recently. It is, he reckoned, "no more accurate than flipping a coin". But they're both wrong. On average, the stock market actually loses 1.8% of its value each summer. Compounded over a couple of decades, that makes for a tidy sum...an overall loss of 30%.
That's certainly been the case during the summer (apologies to Antipodean readers who will need to substitute 'summer' for 'winter') of 2011, which has been particularly bad for investors. The Dow Jones Industrial Average is currently around 12% off its May highs, while the FTSE100 Index is down over 15% from its corresponding high.
Whilst the St Leger saying was originally intended to refer to stock markets, it doesn't stop there though. A consequence of thin trade at any time of year can be excessive market volatility, and just about every market (including Forex and commodities) has seen wild and often unpredictable daily swings over recent weeks as those remaining players who elected to stay behind their desks this summer have mulled over the consequences of a fresh global debt crisis.
Unfortunately, this can have a damaging impact on nearly all automated trading systems. The vast majority of automated systems will follow a combination of indicators upon which they base their trading signals, and these indicators, by their nature, will lag the price action. The result of a thinly traded volatile market is that market prices are finishing their vicious moves before the indicators are able to react and serve up their signals to enter trades. And then, by the time the indicators have caught up with the price action and finally decide that it's right to enter a trade, the market is ready to swing back in the other direction and a lot of those automated trades end up being stopped for a loss.
To illustrate the woes that have befallen automated trading systems over recent weeks, let's go back to the end of June when my Robot Leaderboard looked something like this:
Everything was running tickety-boo at that time, and a number of robots were starting to forge a reputation for themselves in terms of both profitability and safety.
And now, just two months later on, that same leaderboard looks like this:
Positions may have changed slightly but, clearly, the same group of 5 or 6 robots continue to dominate the top of the Leaderboard. The good robots haven't gone totally bad, and are still profitable overall in my forward tests, but the profit factors of all robots seem to have fallen, win rates have declined, drawdowns have increased and, in general, none of the top robots can be considered as safe now as they were just a couple of months earlier.
I don't believe there's anything to be gained from targetting specific robots which have underperformed these last few months, simply because just about every robot has underperformed during the recent conditions. In any event, it's easy enough for anybody to see which ones they are from my Leaderboard without me adding to their humiliation. It is worthwhile noting, however, that the Real Profit EA is finally clawing its way back up the leaderboard after a lean spell lasting several months. I do believe that this could prove to be a good long term EA on the proviso that it can successfully get its trades away with minimal slippage at the time of day it trades.
Now, for what it's worth, none of the robots have drawn down any more than their expected level from the backtests that I carried out as part of my reviews. In truth also, I can't even claim to be surprised that the drawdowns have occurred (the expectation was always for them to drawdown at some stage), so I'm certainly not alarmed by it in any way. One reason I'm not concerned at this stage is simply that I make a point of limiting my risk to ensure that I'm never overtrading.
Being the eternal optimist, I also believe there are some valuable lessons that can be learned from the last couple of months. One such positive should be to never underestimate the benefit of quality long-term strategy tests when deciding whether to use an EA and setting it up to trade live.
Another lesson should be that there is no such thing as a get-rich-quick Forex robot. A robot which has been backtested over 10 or 11 years and which exhibits long term profitability and stability should never be judged on two or three bad months which are irrelevant when viewed as part of the long term outcome.
Finally, a lot of people are successful through good timing rather than through anything else, and there's certainly an argument that some form of contrarian investing could be used with Forex robots to enhance performance. By that I mean, provided you have a long term profitable robot, it could be better to turn it off completely when it's outperforming and to turn it back on again when it's underperforming.
Remember that the Warren Buffetts and George Soros's of this world are renowned for buying low and selling high, and the same methodology can be applied to any number of different instruments.
So how do you know when a robot is outperforming and when to turn it off?
Well, the obvious answer is from the backtests! For instance, if the backtests suggest a long term Profit Factor of 1.5 and your EA is currently returning a PF of 1.6, then it's undeniably outperforming. Similarly, if a recent drawdown has taken the PF down to 1.4, then now could be as good a time as any to start using it again.
It doesn't have to be PF though; you could easily use other statistics such as Win Rate or simply track the current drawdown to decide when best to turn a robot back on.
Hopefully, in my next update in a month or so's time, the good quality robots will have started to perform again once the City boys have been back at their desks for a few weeks. For now though, I've seen a new frock that I like and I'm dusting off my hat ready for Ladies' Day.