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Is it time to Pull the Plug on Helix?

November 22, 2004

 

What has happened to Helix.…..The system which stormed onto the scene this year with a number one ranking in Futures Truth and gains of over $22,000 per contract in actual trading this April is in the midst of its worst drawdown in history.

The numbers don't look pretty, with Helix having lost money in 22 out of the last 28 trading days and 6 out of the last 7 months on its way to a new max Drawdown of ($34,437) as of today. That puts the system down over 17% for the year, and at the lowest point of a 7.5 month, 44% drawdown which started in mid April and hit a new low after another loss today of $1,675

These numbers are far from the system's hypothetical testing which showed an average annualized gain of just over $78,000 per year, or 104% per year on the developer's recommended initial balance of $75,000, Given these losses, investors want to know…..Is it time to worry? Is it time to pull the plug? The short answer is it is definitely time to worry, but not quite yet time to pull the plug despite the current drawdown being the largest in the history of the system (in actual and hypothetical testing).

The rule of thumb is to always expect the worst drawdown will occur in the future, but what is one to do when the future is now? What is a normal excursion beyond the previous max drawdown, and what level of new drawdown might signal that the system is "broken" and should be reevaluated.

Let me first say that system's don't "break". No system simply stops working and starts losing money recklessly- what many investors refer to when saying a system "breaks" is when the risk profile moves severely outside of what was expected in first getting into the investment. If one of the premises for investing in the system was a Max DD of only 40%, for example, then the possibility of future drawdowns of 75% should cause the investor to reevaluate.

So if systems don't break, what do they do? They simply become much more risky. So reevaluating your system investment doesn't necessarily mean stopping it, rather analyzing whether you're comfortable with the added risk. The new profile of the system may simply mean a higher allotment of capital to the system or a reduction in exposure to the system (i.e. 2 contracts down to 1). If the system's overall metrics remain very good, stopping a system simply because it has eclipsed its max DD could do more harm than good. For example, despite this year's poor performance, Compass still averages an annualized rate of return over 40%. Its hard to dismiss that because of a new max DD.

Measuring Future Drawdowns:

But let's return to the question of how far past the old drawdown is too far past. Attain Capital has long held the belief that setting the bar at 1.5 times the predetermined, tested, historical drawdown gives a system plenty of "breathing room". This figure was based mainly on the real-time experience our team has had with hundreds of different systems, but admittedly has issues in so far as it has no statistical basis. (Why not 1.35 times, or 2.4 times, etc.). The tested Max DD for Helix was just over $31 K in 1998, making the "line in the sand" based off 1.5 times the pre-trading, tested Max DD equal to ($47,513). While the 1.5 times Max DD level kept many investors from getting out too soon, a more scientific process was needed.

Attain has since evaluated and developed several new and different measures of expected future drawdowns. Again, we should always expect a new max DD in the future, thus want to be prepared for that eventuality when it arrives by calculating an estimated future drawdown.

The first method of measuring a possible future max DD is to run a Monte Carlo simulation using monthly Helix data. The simulation, run 5000 times over 1200 months (100 years), randomly shuffles existing data to give probabilities of future drawdowns exceeding certain levels. Our simulations told us that 99% of the simulation trials saw drawdowns less than 45% or ($34,356), meaning the current drawdown of ($34,437) has eclipsed the level expected to occur with a 1 in 100 year frequency - not a good sign.

The next method was to run an empirical test on available data using the mean, standard deviation, and skew of monthly returns to calculate a drawdown estimated to occur with a 1 in 100 year frequency. These tests allow us to calculate both a Max DD in dollar terms and an estimated max drawdown duration. The empirical test calculated a 1 in 100 yr drawdown magnitude of $39,155 and duration of 15 months. The current drawdown stands just $4,718 away from this "line in the sand".

Finally, we put the six sigma test into effect. To achieve Six Sigma confidence, a process must not produce more than 3.4 defects per million opportunities. Six Sigma standards are common in the production of microchips and high level security software, where the margin for error is razor thin, and in short insures there are six standard deviations between the mean and the nearest specification limit. In trading systems, the mean is your average drawdown, and the specification limit is the max DD you never want to see. The Six Sigma "line in the sand" for Helix is a Max DD of ($37,584), just $3,147 away from the current drawdown.

The table below shows the estimated stop trade/reevaluation levels as derived from each of our four methods, with the average of the three shown. Unlike many other systems, the 1.5 times tested max DD is a not really a valid measure here, as it a good deal greater than the more mathematically advanced methods.

Investors can choose which method they wish to ascribe to, or use the average of the four to measure what point they should stop trading Helix (or reevaluate their trading).

So here we stand, with Helix having lost money in six out of the past seven months, a hair past its Monte Carlo "line in the sand" and just a few more losing trades from the Six Sigma and Empirical levels. By all accounts it is a time to worry. But, for those with foresight it is also a golden opportunity.

How can a system inches away from eclipsing its stop trade levels be a golden opportunity? I'm glad you asked. It all boils down to risk vs reward. Let me ask which investment you would rather undertake:

1. Investment 1: $35,000 risk for $75,000 profit
2. Investment 2: $5,000 risk for $75,000 profit.

There is obviously much more opportunity, and much lower risk in Investment 2, and that is what you are getting with Helix at its current levels, a $75,000 per year opportunity for just $5,000 in risk. A quick study of the second table below shows this has been a great opportunity in the hypothetical testing, with an average gain of 52.8% and 81.1% for the 3 and 6 month periods following the low point of the drawdown. (based on the developer recommended initial balance of $75,000).

It is normal for investors to chase after the hot systems and avoid ones at new max drawdowns, but for any contrarian investors out there who know the benefits of going against the crowd, the Helix system represents a great low risk opportunity. Just be sure you keep it low risk and get out if the system does cross that "line in the sand".

It is important to consider the following table if these levels are hit and it does become time to reevaluate your investment in Helix.(they are only about $5,000 away). The table shows the estimated future Max DD as calculated when including the data of the current drawdown. You can see that the estimated future Max drawdown jumps higher, to over ($52,000), or $14,000 in further drawdown.

One can not validly keep calculating these levels with current data, however, as the stop trade levels become a moving target - and one which may never get hit. This makes it paramount that investors determine their stop trade/ reevaluate levels before starting trading. If you failed to do so before starting the system - don't worry, the averages in the first table above should hold for nearly all investors who currently trade the system. Do worry about how close the system is to those levels, however. Good Luck Helix! You need it.

Jeff Malec