Past Performance Is Not Necessarily Indicative Of Future Results

By | January 29, 2016

Since I published Following Forex Trading Signals Is Dangerous To Your Wealth in November, I received a fair amount of criticism/abuse sparked by my comments on  SPM Capital Management. While I don’t expect too many of those people to reconsider their thinking, I do hope some will start looking beyond the surface when discussing performance track-records. I can summarize the message of my critics as follows:

  • SPM has a very good and consistent track-record – 145% over 15 months with only one down month (-5%)
  • you have only 2 months and you’re down -5% so you’re a bad trader
  • his performance is far superior and therefore you have no business criticizing

Now, let’s look again at the title I chose for this article. It’s not some meaningless, small-print disclaimer that money managers are legally required to display. It’s a very profound statement of fact. To wit: just because trader X has had good performance, it doesn’t mean he will have good performance going forward. The reverse is also true: poor performance up to the present time doesn’t necessarily indicate poor performance into the future. By looking ‘under the hood’ of the strategy/trader, or in other words, doing due diligence, a professional allocator will get a pretty good idea of how indicative the past performance is for future results.

I’ve already mentioned the problems I see with both the strategy and the trader behind SPM Capital Management, so I won’t go into that again here. What I want to drive home to you is the fact that by looking only at the return and draw-down numbers of a track-record, you’re getting a distorted and limited segment of the whole picture.

Some would argue that what I’m saying might be true for track-records that have only a few months, but not so for longer (+1 year) ones. Yes, the bigger the number of trades and length of market exposure the track-record covers, the more significant it becomes. However, we can’t use any arbitrary cut-off point (6, 12, 20 months and so on) to confidently say that because up to that point the hidden risk hasn’t materialized, it won’t ever do so in the future. Think about it: if you’ve driven under the influence/over the speed limit 10 times and got away without any accident or having your driving licence suspended, it doesn’t mean this is the safe and right course of action going forward.

Letting your losses run is one of the most common hidden risks (or time bombs, call it what you like) in trading. I’d say it’s as destructive for a trader as drink-driving is for a driver. Either one of them can use plenty of excuses of why they did it and how they are ‘special’ and won’t be affected by any negative consequence. In both situations, they can get away with it for quite some time. For a while, they can even look smart – think of the trader who cuts his losses and has a negative performance vs the one who waits for the market to come back until his positions are in the green again.

To conclude: high past returns might reflect excessive risk taking in a favorable market environment rather than trader’s skill. Understanding the source of returns – the logic behind the strategy – is critical to evaluate how relevant they are.