Steve Mayo Legend  Posts: 414 Joined: 10/11/2012 Location: Austin, TX  User Profile | what you are pointing out is the problem with looking at simulated equity curves. That pretty curve that OV draws is just one sample out of a whole bunch of possible outcomes. We all tend to look at those pretty curves and immediately think that it has more meaning than what it actually conveys. To make matters worse, we look at "statistics" on that pretty curve, such as CAR and MDD, and let those set our expectations for the future. They might be accurate, but only in the astronomical chance that the future is exactly like the past, and more particularly that the future is like THAT SPECIFIC slice of history that we simulated. Instead, we need to be looking at ALL the possible outcomes, and as much as is possible, apply some probabilities. The proper tool for that is distribution curves or box plots, but most people get glassy eyed even at the mention of such things. People don't understand probabilities, (look at the success of the lottery or the over-reaction to Ebola as examples). We all want a clean single number...and thus all technical analysis programs, be it OV, Tradestation or whatever, must give us, the customer, what they want to see, a pretty equity curve...so we can let our greed go wild. Going back to that example I provided above. The OV simulation had a CAR of 44% and an MDD of 19.5% which sounds pretty good, but if you take that historical data and look at all the possible outcomes (using bootstrapping and Monte Carlo analysis), you find that this particular OV portfolio has a mean of around 35% (geometric mean or "CAR") and a standard deviation (of this CAR) of around 30%. In other words, that 44% CAR shown by OV is 0.3 standard deviations above the mean, meaning that you really only have a 35% chance of getting better and a 65% chance of doing worse. To end on a high note, the mean on the equally-leveraged SPY buy&hold portfolio was about 23% with a standard deviation of about 22% so the OV portfolio has a slightly better volatility-adjusted return (Sharpe) and per the rolling distribution curve it's higher volatility seems to be on the positive side. SteveM Corrected to confirm that I was using the proper geometric (CAR) means in my analysis and to upload the graphs [Edited by Steve Mayo on 11/17/2014 2:16 PM]  Attached file : Cursor.png (41KB - 290 downloads) |
