Has Your Holy Grail Gone Through Phase IV Clinical Trials?

  • August 16, 2000
  • Eddie Kwong

If you’re newcomer to trading, there is one piece of
advice that practically all successful traders will tell you at some point:

There is no Holy Grail.

I went through “a Holy Grail phase” myself during my early days as a
trader. Boy, was I misguided. 

Today, it dawned on me that what throws people off–the reason why traders
start off believing that there’s a foolproof mechanical system that will make
then an easy fortune–is that they tend to draw wild conclusions based on a
small amount of evidence.

In spite of the many articles written about the dangers of historical
back-testing and curve-fitting, even seasoned traders will still sometimes fall
prey to being overly optimistic about how well correlations they’ve seen in the
past will help to predict market action in the future.

One thought that occurred to me when I saw the following chart of BEA Systems
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PowerRating) is that many indicators will appear to work extremely well for short
periods of time. These are the data samples that convince novice traders that
they’ve found the Holy Grail.

In this chart of BEAS, showing a six-month period of price action, the stock
bounces off its 200- and 50-day moving averages quite reliably. While I don’t personally
know of anyone who’d trade off moving averages, I do think there’s a good chance
that I could convince a group of beginning traders to pay me $3,000 to teach this
new miracle technique of mine through a weekend seminar.

But, of course, that would be wrong. What I would really teach
them is that you can find correlations that are short-lived and which may be
useful for a short-period of time. But you must keep in mind that the
personality of the markets is in a continual state of flux. Most indicators
that appear to work extremely well today, will not work very well tomorrow. If
you keep that in mind, you can exploit today’s Holy Grail for all it’s worth and
then tomorrow, look for the next short-lived Holy Grail.

See you tomorrow,

Eddie