Ideal Timing for Large Lump Sum Investment

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Old European
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Ideal Timing for Large Lump Sum Investment

Post by Old European »

I'd like to start up a small discussion on the ideal timing for an initial or additional large lump sum investment in mechanical systems.

In my previous life as a discretionary fund manager, I always tried to minimize the risk of poor investment timing by spreading the initial investment of a newly created fund or of large additional inflows into an existing fund over time.

I'm wondering now whether I shouldn't be a bit more ambitious and try to time investments in mechanical systems. I'll explain why.

When originally developing mechanical systems, my favorite gain-to-pain ratio was modified Sharpe (i.e. Sharpe with zero risk-free rate). I prefered this over the more popular MAR ratio, because I thought that modiied Sharpe would give a better indication of the smoothness of the equity curve, since volatity is measured over the whole test period while maximum drawdown is just a one-time event. So I then started sorting my test results by modified Sharpe. I however noticed quickly that sorting by modified Sharpe or sorting by MAR didn't make that much difference and this was the case for almost all systems I looked at. Digging further I discovered that the reason was that maximum drawdown is not really a one-time figure that is much larger than other typical large drawdowns over the same test period (e.g. over a 20 year test period the 10 largest drawdowns may be 19%, 20.8%, 21%, 22%, 22.2%, 23.5%, 23.6%, 24.7%, 24.9% and 25% with 25% the maximum drawdown; I was expecting more something like 9 numbers between 20% and 25% and a one-time maximum drawdown of maybe 40% or even more).

Most decent long-term mechanical systems with a large investment universe (e.g. more than 30 futures markets) apparently have very well-behaved (or even predictable!) drawdowns. They occur with a certain regularity, don't last too long and maximum drawdowns that are much larger than the typical large drawdown of a system are very rare. This can only mean that nice trending market conditions continue to develop with a reasonable frequency.

It is therefore very tempting to try to invest in a proven (in tests and preferably with real money) mechanical system at a time when you are experiencing a typical large drawdown.

And since most long-term trend-following systems and CTAs are witnessing large drawdowns at this moment ...

I'd really appreciate any comments on the above.

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Post by shakyamuni »

You might like to read this.
(61.5 KiB) Downloaded 552 times

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Post by Sir G »

Yes.. the Basso report… I remember that one. The survivorship bias IMHO is the big downside to that study.

But if you have done studies in position sizing, you will make note that one of the edges you will get by trading a fixed fraction or anything like that is you are subsidizing the markets in drawdown at the expense of the markets at equity highs. If your Equity Curves were living beasts, this is the opposite of positive behavioral conditioning, but it does back up Tom Basso’s findings that you can improve your risk adjusted returns by subsidizing those instruments where equity curves are at lows, by pulling from the ones that are at their highs. As long as the ones going down stop going down!

In your observations Old European, you made note that investing when the markets get down about 19% would have historically limited your risk.

Personally, I’ve never subscribed to this way of thinking. I would rather tend to the opportunities at hand and let the numbers take care of themselves. Diversification and small bets are the kinds of things that I would rather look at as investing in something that is down is very possibly on its way all the way down. In the end, buying death at a discount isn’t really a deal.

But with that being said… when you are diversified and betting small, drawdrawns are a positive as they are simply the exhale prior to the next inhale.

I think the answer to your question Old European is whenever you are comfortable to begin to trade the funds, that is the time you should commit to it.

Cheers. Gordon

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Post by Rocky »

There have been a few papers written on this subject. I'm not sure that they're still there, but there was one on John Henry's site, and another on Dean Hoffmans site. Most of which agreed that investing in a system that is in a drawdown is a good place for additions.

This is true......until it isn't. Ex. I was trading a LTF. Had run tests all the way back into the 70's. Worst Casce Scenario's, Compounding, non compounding, Best month to invest, rolling returns, STD's, CAR's, Longest run ups, longest drawdowns, etc. etc. etc. Had virtually every statistic known to man. Especially the ones that showed the runups that occurred after major drawdowns. A very good and stable system. I traded it mechanically WITHOUT FAIL. Because of my size I was risking 2% with the knowledge that 35% drawdowns were within expectation. I had lived through them. But I also wanted to build my stake. Had been trading the system for over three years and was very comfortable. My own stake, not including friends, was a tad over 200 grand. I wanted to boost myself to the next level ( get my stake up to 500 grand) but how was I to do this?

Well we went into a drawdown. When it reached 28% I knew I had a greater than 97% confidence level that it wouldn't go over 35% and over 99% that it wouldn't go to 50%. Interest rates were the lowest in history, so I borrowed a million dollars, knowing that the drawdown might not be over, but that we were close, and that the ensuing run up would put me at my desired trading level at which point I'd remove the million and pay off the loan.

Needless to say that didn't happen. After a few wiggles, the system went to an all time new drawdown. The greatest in 30yrs. Ended at 55%. We had to shutdown our little fund because we had put in a limit of 50%. I had to withdraw because I had lost my stake, and couldn't risk my families future on borrowed money.

Is the system broken. Truthfully I don't believe so, it's gone through a bad time like all do. Some would say "trade through". Once again, not a choice on borrowed money and I'm really glad I didnt since most LTF's are still playing in the mud. I'm in the process of saving up another stake to trade again asap.

I don't tell this to be told how silly I was to borrow money, or cry the blues about my particular plight. I'm a big boy, made the decisions based on the information I had at the time and don't regret them. Just want to point out that sometimes statistics aren't all what they're cracked up to be, and just because you're at extremes doesn't mean you can't go farther.

Be careful.


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Post by MorganSys »

be careful that there is no selection process towards controlled drawdowns in your optimization routine.

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Post by damian »

Rocky wrote:There have been a few papers written on this subject......Most of which agreed that investing in a system that is in a drawdown is a good place for additions.

This is true......until it isn't.

I am yet to be a great trader by any measure so perhaps my real experiences are not much for others to form opinion off of, however:

At 35% drawdown I added more capital. 12 months later and I am at 60% drawdown; stopped trading and waiting to add more capital and start again.

It is to say the last an interesting juncture. It was never really supposed to go this way and I keep reminding myself that in the drummed up pre-trading days (and days of profit) it was always easy to sprout words like “anything can happen and probably willâ€

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Post by Old European »


Thanks for bringing Tom Basso's paper to my attention. Seems to confirm my point.

Sir G,

Indeed 'buying death at a discount isn't really a deal'. In my previous life as a discretionary fund manager I always tried to avoid throwing good money after bad money and I considered 'averaging down' as unwise.


Thank you for sharing your experience. I can imagine how cruelly you have been treated by the markets (and they don't have any compassion!).
One indeed has to be very prudent in interpreting system statistics.

Maybe I'm exagerating a little, but to be on the conservative side I divide the MAR ratio of the test results by a factor of 2 (75% of CAGR and max TE drawdown plus 50%) to have an idea of what I should expect over the next 10 years. Financially and psychologically I can live with a 40% drawdown, but I'll work only with a system that has historically generated drawdowns of maximum 25%.


Optimizing towards controlled drawdowns is indeed dangerous. I'm not really doing this. I'm only observing in my tests over and over again that the maximum drawdown (e.g. 25%) is not much out of line with a typical drawdown (e.g. between 20% and 23%), so that when witnessing a 22% drawdown the downside of an additional investment should be limited to 3% (plus some safety margin).


Your story is very similar to Rocky's. I sincerely appreciate your advice.

Thanks all of you!

Old European

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Post by JonS »

Rocky and Damian, thanks too for your posts.

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Post by AFJ Garner »

Similar experience to Rocky and Damian - started trading through an excellent robobroker when a certain LTTF system was at a 20% drawdown - worst for 20 years on the portfolio chosen. Guess what? It went to about 38% and has not yet recovered.
I can further support the fact that, while backtesting and research are absolutely vital, sods' law will undoubtably catch a few of us. Having got fed up with returns south of 2% in dollars and Euros I made a few hedge fund investments late last year and the begining of this.
Guess what? Hedge fund returns have been the worst this year since the Russian/Asian/LTCM crisis in 1998.
Sigh. Luckily I did not commit too much capital.

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