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Backtests, Trading Calls & Fake Gurus - How they all are rigged to fool you, with example of ITC

Updated: Jul 19

Note: A video version of this blogpost is available at: https://youtu.be/65Z_j0LXATs


This is a blog post on how the game is rigged against gullible newbies. From beautiful looking backtests to best trading calls/picks to fake/unexperienced trading gurus - everything out there is get you! None of these exist to help you, but the creators. I can't promise you riches, but can assure that if you read it until the end, you may find useful information in it.


Recently, I posted a tweet on my Twitter channel, aimed to be a sarcastic take on the way dreams are sold in the markets.

There were several, subtle hints in the post to imply that what I am writing is sarcastic in nature.

  • The post named the strategy as "MAGIC WAND" - we all know there is no Magic Wand in market that can help you mint money easily

  • The post asked for retweets or 50,000 INR - for something as ridiculous as it was showing.

  • It used a catchy popular stock - #ITC - to have more people assume that this is true.

You can check the post below and associated graphic that I used for #ITC Stock.


Poster used in the Tweet
Poster used in the Tweet

The above poster was used in the tweet and it shows #ITC daily closing price in Blue and then a chart in Green that appears to be a strategy output. The charts are perfect example of things that look too good to be true. Surprisingly for me, the reaction that I got for my post was of people trying to guess what the strategy is. While, some smart folks did ask questions on authenticity of the results, many were happy to seek the results. This brings me to the first important point of this post:

If something seems too good to be true, it probably is TOO GOOD TO BE TRUE.


BEAUTIFUL BACKTESTS

You attend a "Free" webinar/session online and notice the presenter providing a beautiful looking backtest. This backtest will have a very clean growing equity curve, very small or almost no drawdowns and like extraordinary total returns(500%-1000%) over a span of 10-15 years. Your eyes lit up - this is the type of outlet you had been waiting for to deploy your idle capital and move towards your dream of being financially free.

Unfortunately more often than not, these backtests are just that - "Dreams" - with difference being that Dreams do come true sometimes. But the probability of the backtest shown to you being realistic is almost Zero.

There are no easy systems/ways to make money in the markets. Such beautiful looking backtests may have the following gaps:

  1. It has been over optimized - That is the parameters have been selected to only present the best possible outcome. Example - if it is using a Moving Average, it will show a crossover of MA(19) and MA(31) and will tell you this is the best combination. Or in case of Straddle selling, it will select time such as 9.23 AM to enter and 2.56 PM to exit. There are possibly no reasons for such odd selections to have any positive prediction expectancy. In the end, when you take such systems live into trading, you'll observe that performance is way different from what was expected.

  2. It does not make realistic trading assumptions. Trading is not frictionless, there are all sorts of costs we pay to be able to just trade. While brokerages and taxes are obvious costs, Slippage is an equally important but hidden cost of trading. A lot of times, the backtests assume to be able to trade on Market Close prices. This is not possible in a market like India where "Market on Close" orders are not available, unlike the US markets. The backtest may assume the "Daily Close" price to be actual price, but in reality that price is not the "Last Traded Price", but average of last 30 minute auction price of the stock being traded.

  3. There is no In-Sample/Out-Sample data in the testing. That is, the entire data available has been used in the backtest and the parameters of strategy has been highly curve fit. Similar to point #1 above, it results in over optimized outcomes.

I can go on for pages on what could be possibly wrong with the bactests, but these are the starting points. These backtests are rigged - rigged to make you believe that such rosy dreams are possible in markets.


SURE SHOT TRADING TIPS & FAKE/INEXPERIENCED GURUS

What does it take to become a Trading Tips provider in the market? Nothing - Absolutely nothing. I can post a trading tip tomorrow morning for you to BUY XYZ stock at any Price. I can give 10-20 picks over a period of the week. By random chance, there is a probability that half of those calls will make money at some point. You'll see the original call provider saying -

FIRST TARGET MET. SECOND TARGET MET. THIRD TARGET MET. ENJOY OUR CALLS

So what's wrong with that? Well, a few things:

  1. The other half of the calls that did not do well, are not shown. Let alone shown, the results of what happened to those picks are not shown - likely because they bombed

  2. There is no clear Profit output from these. Let's say trading call was given as: BUY STOCK ABC at 100 Rs, Tgt1: 104, Tgt2: 108, Tgt3: 115 - Now, If the target 1 is met and stock reverses, then the tip provider will say T1 met and use that as result. However, if the stock continues up and meets Target 2, the tip provider will now say T2 met and use that as result. However, in LIVE TRADING at the time T1 of 104 is met, you do not know if it is going to continue or not. Let's say you exit at 104, and market goes up to 108. The tip provider will use 108 as result, whereas yours is 104. On the other hand, let's assume you did not exit at T1(104) and waited for T2 (108). Markets reversed from it and you end up taking a loss by selling at 99. The tip provider will pick T1 met as the result. So you see - their results are geared towards gaining maximum possible from the move, not what's realistic trading results.

Lastly, some of these tip providers will become Trainers/Gurus. They will promise you to make you successful - Overnight. Something I wrote in my original post above - to bring your attention to it. It sells dreams.

While, there are genuine Gurus/Trainers in the market, who may actually be able to teach you something useful for markets, most of them are just outright Shams. Don't fall for them - ask pointed questions to them before you pay them a penny. Most of these traders won't even trade on their own LIVE Calls. So why should you?

Remember, it's incredibly hard to make money in markets, following an inexperienced Pied Piper will only lead you the same end as those of the mice following the piper in the famous story.


HOW DID I CREATE THE BEAUTIFUL BACKTEST?

I was researching some trading aspects on stocks in Indian markets. I have in the past Hypothesized that the real returns of a trading asset are made to compensate for risk of holding an asset overnight. Intraday trading does not make money in long run. I had also tweeted about it some time back.



So I set out to test out this effect on the Indian stocks market. I created the following pseudo code and executed it using Python:


## Plot the Closing price of ITC Stock 
import pandas as pd
import matplotlib.pyplot as plt
filepath = r'C:/Documents/ITC.csv'
data=pd.read_csv(filepath, index_col=['date'],parse_dates['date'])
data['close'].plot()

My Data is for about 5.5 years and the code above gave me the following chart. It shows the Daily Closing price of "#ITC" stock.

I then proceeded to separate the intraday and overnight returns for the stock. Intraday returns are simply the return from Open Price of a day to Close Price of the same day. Overnight Returns is calculated using Open Price of today with respect to Closing price of yesterday.

Here is the code for that:


## Intraday Returns
data['ID_ret']=data['close']/data['open']
## Overnight Returns
data['ON_ret']=data['open']/data['close'].shift(1)
## Plot
### Skipping formatting of plot here
data['ID_ret'].cumprod().plot()
data['ON_ret'].cumprod().plot()

As you can see in the following chart, the Overnight returns of the stock completely eclipse the intraday returns of the stock. Even for a range bound stock like #ITC the overnight returns are almost secularly increasing. Here is the chart:


Once I observed the above pattern, I went on to create a chart for only overnight returns of the stock. And that brings me to the following beautiful chart. The chart that I showed as the backtest results/strategy. It is nothing but simply "Overnight Returns" of the stock. There is no "MAGIC WAND" in it that can transform any stock into a beautiful curve.



if I were to scam you, I can teach you a strategy to Buy #ITC at the close of everyday and exit at the Open of next day. A perfect BTST trade that you can do everyday to mint money. Without taking into account any of the previously mentioned caveats, this chart is aimed to fool your untrained eyes/mind into believing that such outcomes are real. They are possible.


Let me burst your Bubble - They are not!


WHAT ARE THE LEARNING(s)?

If you have to take anything from this write up, please take back the following two points:

  1. Trading in markets is not easy. Making money is further difficult. If anything/anyone promises you an easy path out, turn around and run away.

  2. Stocks exhibit a behavior in which overnight returns of the stocks far eclipse the intraday returns. Think of the ways you can harness this effect.

I hope you found this useful. Wish you good luck in this jungle of markets. Stay Safe and I hope you succeed.


- Ankit

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