Here are some of the most frequently voiced concerns, objections or questions relative to trend following, quantitative trading strategies and the I-System.
How can your model ‘know’ if XYZ happens?
This is the most commonly voiced misgiving about quantitative strategies. A good example of “XYZ” happening is the event A in the following chart.
“A” marks the largest recorded 1-day oil price jump. On Saturday, 14 Sep. 2019, a missile attack in Saudi Arabia caused substantial damage to Aramco’s Abqaiq oil production facilities. The following Monday, oil price closed $8.42/bbl above previous Friday’s price. Of course, I-System strategies didn’t ‘know’ this would happen and held 60% short exposure at the time. As a result, the portfolio sustained a $5.80/bbl average loss (4 out of 20 strategies had long exposure).
Such an experience can easily induce traders to react emotionally. But impulsive trading around on-going events can make things worse. By contrast, disciplined adherence to predefined and tested decision-making rules enable traders to resist getting caught up in the commotion of the moment. In this sense, I-System guidance is not a weakness but an important strength. Over longer time-horizons, its consistency in the face of uncertainty pays off, as the next chart clearly shows: