Moore Research Center, Inc.

The following article was originally published in August 2001. Some minor edits have been incorporated for readability, but all information is still current as of that time.

In a world in which account size and margin are irrelevant and counter-seasonality does not exist, trading a seasonal methodology is a no-brainer. You simply enter and exit seasonal strategies on the appropriate days for each trade. In other words, your account is large enough to take every strategy without worrying about whether you have enough margin or whether this will be the year in which a particular strategy decides to head south. Unfortunately, few people have both the resources and the desire to take every single seasonal strategy and also to sit through any and all drawdowns.

Moore Research Center, Inc. (MRCI) has found that our own previously published seasonal strategies would have generated optimal results by trading each and every strategy and without using stops. In real time, however, traders must be practical, for most have limited or, at least, finite resources and do not inhabit the hypothetical world of unlimited funds. Thus, drawdowns and allocation of resources are vitally important components of trading. We intend to introduce several ways to evaluate seasonal strategies to optimize selections before even considering technical or fundamental analysis, instead addressing margin, historical return, consistency, and volatility.

Performance Bond (Margin)

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No analysis of return would be complete without discussing margin (performance bond) and its restrictions on diversifying a portfolio. An example of where this could be extremely important would be in trading S&P 500 futures. The current exchange minimum margin(on June 11, 2001) for the full-sized S&P 500 was $21,563 initial/ $17,250 maintenance. However, the initial margin for the E-mini was only $4,313, while maintenance is $3,450. Many traders would better utilize their funds by trading E-mini contracts instead of the full-sized version, saving funds to diversify into other markets with other strategies.

Historical Return

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The basis for our analysis of historical return is a December British Pound seasonal strategy:

Incorporating margin into a basic analysis of rate-of-return results in the following formula for the above British Pound strategy:

This computation takes into account the relationship between the strategy's historical profit, current margin, and length of exposure. To illustrate the point, if we compare an S&P 500 strategy with the same historical average profit but with an initial margin of $21,563, the value would be approximately 41%. Stated another way, historical average profits of $22,331 would be required to get the same rate of return on margin required. Thus, the former appears to be a much more palatable, realistic, and profitable strategy.

Consistency

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To evaluate consistency, let's examine the December British Pound strategy detail.

Upon evaluating the Best Equity Amount and Profit Amount columns, we see that 12 of the 15 years saw an open equity greater than the historical average profit and 10 of them closed out with equity greater than the average. This trade has been extremely consistent. This type of consistency would seem much more reliable than one which saw an open equity greater than the historical average in, for example, only 7 out of 15 years and which closed greater in only 5.

Interestingly enough, in this example two of the three years, which did not see at least the historical average, resulted in losing trades. One (2000) never had a closing profit at all, while the other (1986) peaked three days into the trade and then failed. Looking at a chart, we see that the market did make one attempt to rally but failed before selling off dramatically. The third year (1992) deserves separate mention. This particular year saw significant early open equity but then lost dramatically. We mention this separately because this was the result of a one-time governmental intervention which directly devalued the pound and which could not have been foreseen by historical research. Do your homework! When you find catastrophic results like this, try to find out what happened and why and then evaluate the probabilities of something similar happening again. Attempt to analyze around the results. Do not forget about them, as they are a potent reminder of how risky trading really is, but attempt to exclude such extremes when evaluating practical stops.

Volatility

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When discussing volatility in this particular instance, we're really talking about comfort. Is this trade so wildly volatile that enormous drawdowns must be suffered in the hope of ending with profits? Or can one sleep nights, enduring an acceptable level of volatility (acceptable being relative for each individual, of course). In this particular case, we attempted to optimize a protective stop by evaluating every possible value from of $50 to $13,800 (1992's worst drawdown, rounded up) in $50 increments. This stop optimization, shown in the accompanying graph, resulted in an optimal stop of $1,750. (Note the dramatic saw-tooth transitions as each year's worst drawdown is picked up and historical profit increases until the next, with the peak amount showing up between the drawdowns for winning and losing years.) Using $1,750 as a stop, this trade would have succeeded in 11 of 15 years and raised the average annual return to $1,933. So, by simply analyzing drawdown, one could have increased the average annual return by over 30% with a only minor drop in winning trade percentage. In addition, one could have predetermined his dollar-risk to only 19% more than the theoretical return.

There are other methodologies for establishing personally acceptable risk. The primary concept is that it simply needs to be accomplished. One may not always be able to improve return while reducing risk, but the idea is to sleep better and play the game longer.

Conclusion

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Finally, every seasonal trade is not for every trader. Account size limits ability to absorb risk as well as to diversify and to maintain multiple positions. Personal temperament determines one's emotional ability to accept risk, to weather drawdowns, and to "stay with the program." The amount of time available to monitor and evaluate markets also drives how selective a trader can and must be.

The purpose of this discussion has been to help traders with finite resources to evaluate and better select from among potential seasonal strategies to trade in real-time without, or at least before, analyzing current technical or fundamental conditions. Even the best analysts cannot see into the futures and predict what the market will do. Thus, taking the time well in advance to objectively evaluate the relative merits based on current margin requirements, rate of historical return, consistency of gain, and volatility of a group of seasonal strategies can make the difference between sleeping well, surviving, and prospering versus becoming only a spectator.