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Actual / Hypothetical - Making sense of Trading System Results.

August 15, 2005

 

"Past performance is not necessarily indicative of future results", "Actual results may vary", "These results are hypothetical" - What does all this mean? How is an investor to wade through pages of disclaimers to see how a trading system has really done?

All of these disclaimers are in place to protect you - the investor - from investing in something you supposedly don't understand, and are required in one form or another by the government through the Commodity Futures Trading Commission and the National Futures Association. The disturbing issue that the government believes they know what you can and can't understand is an argument for another time and place.

Because there has been more than one case of an unscrupulous system developer, trading advisor, or hotline/chatroom guru duping the public by posting outrageous performance claims, the regulations require any performance not verifiable in an actual client account statement on file to be labeled as hypothetical - with the lengthy hypothetical disclaimer warning how future results could have absolutely no resemblance to the hypothetical track record attached.

But what happens when everything is labeled hypothetical? The investor reads the disclaimer and now knows that the hypothetical record may be significantly different than the actual track record, but he has no data on the actual performance. That is what the investor needs to make an informed investment decision.

Many investors looking into trading systems point to Futures Truth as a source for how a system has really done - but few realize that Futures Truth is also reporting hypothetical results. While futures Truth is a good source for viewing system's hypothetical performance after they have been released, nothing in Futures Truth has actually happened in an actual customers account.

Attain Capital believes investors need to know how publicly available trading systems have really done, in actual client accounts, and in that light tracks every single client fill on every system traded at Attain. But wait, you say - the performance reports at www.attainaccess.com are labeled in one of two ways. Either 1. Hypothetical Model Account Using Actual Client Fills, or 2. Hypothetical Model Account using Computer Generated Fills. Why do both still say hypothetical?

How can a model account using actual client fills be labeled as hypothetical? We're glad you asked. The performance reports Attain Capital produces using actual client fills are 100% actual in that they show the exact dollar profit or loss per contract experienced in each client account trading the referenced system that day, but once that dollar figure is converted to a percentage return, the results must be labeled hypothetical.

Dollar based Returns:

To illustrate why this is so, consider the Compass trading system's July 2005 results. Looking in the 'View All Trades' section of the Compass Performance report on www.AttainAccess.com, you will see the table below showing the Compass system had 13 trades in July for gross total profits of $2,546.75 per single S&P 500 contract.

- Past Performance is Not Necessarily Indicative of Future Results -

Each of the buy and sell prices and each P/L dollar amount represent actual performance - as Attain can show a copy of any one of its customers (trading that system) January account statement and reveal 13 trades totaling no more than $2,547 per contract. Indeed, the daily profit or loss reported on our site comes directly from these customers' statements.

Did every customer trading Compass with the full size S&P make $2,546.75 per contract in July? What about split fills? - I'm glad you asked. Split fills occur when different numbers of contracts get filled at different levels on a system order.

Consider July 12th, when Compass made $511.75. This amount of gross profit should not be possible - as it represents 2.047 points and S&P futures only trade in 1/10ths. This trade is an example of a split fill. As an example, imagine 10 people were trading Compass that day, and in exiting the trade - five people got filled at one price and five at a worse price. It would not be fair for some investors to make more money on that trade than others, so Attain uses what is called APS, for the Average Pricing System. This is a fancy name for giving each investor the average price of the different fills, insuring every investor trading the system gets the exact same fills - and therefore achieves the exact same profit or loss for the day, month, or year.

Getting back on topic - we have explained above that dollar returns are actual performance, as that dollar amount (on a single contract basis) is in each investor's (trading that system on that specific day) account.

Percentage Based Returns:

Now comes the hard part, which is percentage returns. Percentage returns cause much of the confusion - and much regulatory red tape. The regulators don't like them - but investors are nearly totally reliant upon them, being force fed percentage gains and losses daily on CNBC and other financial media. Investors are looking for xx% return, and talk about xx% drawdowns - but the regulators don't want futures brokers talking about percentage returns without extensive disclaimers. Again - to protect you the investor, from yourself.

Why are percentage returns taboo? Let us turn again to the Compass system in July to illustrate. Looking again at the Compass system's performance summary on www.attainaccess.com, we can see that the system enjoyed a nice 5.7% gain last month. How did we come up with this number? The disclaimer on the bottom of the performance summary states: "For those systems which do not use compounded equity for new positions (mainly day trading index futures systems like Compass), percentage returns are based on the initial capital amount listed in the 'Description' section of the report and include commissions, fees, and the cost of the system. The hypothetical account is reset to the initial capital amount listed in the 'Description' section of the report at the beginning of each month in calculating monthly percentage figures. "

But wait, we stated earlier that the system had gross profits of $2,546.75 in January. Wouldn't this be $2,546.75 in profit divided by the initial capital amount of $30,000, for a percentage return of 12.32%. ($2,546.75 / $30,000 = .0848 = 8.48%). Why is the gain only 5.7%? Looking more closely at this performance summary page, we can see a note directly above the Monthly percentage returns stating: "Returns Inclusive of $50.00 commission per trade and noted system cost."

Thus the $2,546.75 in gross profits is adjusted downward to take into consideration the effects of commissions ($50 * 13 trades = $650) and the monthly cost of the system ( $199), for a net gain of $1,697.75. This amount divided by the recommended initial balance of $30,000 gives you the stated monthly gain of 5.7%.

If your still following, here's where it gets interesting. The second part of the note above the percentage returns on the performance page states: "Actual investor returns may vary due to numerous factors, please see important risk disclaimer below." These numerous factors are the fact that different investors have different commission rates, start and/or stop the system at different times, and most importantly, fund their accounts with different amounts of money.

Turning back to our Compass example, let us consider three different investors who all started trading Compass on July 1st, 2005. Investor 1 has a $1,000,000 account, investor 2 a $10,000 account, and investor 3 a $30,000 account. Assuming each of these investors was trading a single S&P contract per the Compass signals, all three would see the same dollar gain in their account as of the end of the month - with $1,697.75 in net profits (assuming each has the same commission cost) being posted to their accounts. However, their percentage returns would be significantly different, with investor 1 at just a 0.17% gain, investor 2 at a 16.98% gain, and investor 3 at the reported gain of 5.66%.

 

This simple example shows just how different percentage returns can be, and for that reason the percentage returns listed throughout Attain's website are labeled hypothetical - even though they are derived from actual customer dollar gains and losses. They are hypothetical because any one investor's percentage returns would be greater or less than those listed based on factors such as starting balance and commission rate.

To give investors as clear a picture as possible, Attain bases the hypothetical percentages off of realistic numbers by using the developer's recommended starting balance level and including the cost of the system. Furthermore, Attain paints as grim a picture as possible by calculating returns inclusive of a $50 commission, eventhough most clients start at just a $40 commission. This conservative approach deliberately errs on the side of reporting performance worse than most customers would see. Besides making the real thing feel that much better when posted to your account, a system which can remain attractive after being "stressed" with a higher commission and the cost has a great chance of remaining robust for a long time.

So please do read those lengthy disclaimers you see on this and other sites. They are not just telling you to be careful of the risks - they are also explaining how the returns you are viewing are calculated, whether they are from actual accounts or not, and much more. If you are looking at a website without a disclaimer explaining the results listed there - or perhaps one of those ads in the back of magazines touting hundreds of thousands in profit (without a single mention of how that profit was made, or the risks involved), don't be the least bit surprised if the returns on your hard earned dollars differ dramatically from the ones listed.