Key Considerations When Evaluating a Strategy Sold by Others
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When evaluating a strategy sold by others, focus on understanding the thesis, checking its robustness over time, and ensuring it doesn’t rely on excessive leverage. Compare it to a buy-and-hold approach to assess if it truly adds value.
When purchasing a trading strategy from someone else, it’s important to evaluate it carefully to ensure it aligns with your goals and risk tolerance. Here are the most important factors to consider.
Understand the Thesis
The first step is to understand the core thesis behind the strategy. What is the main signal or rationale? Is it based on trend-following, mean reversion, or some combination of factors like momentum or volatility? Knowing the foundation of the strategy helps determine if it fits your trading style and market outlook.
• Is the strategy designed for specific asset classes like stocks, futures, or crypto?
• Is it reliant on technical indicators, or does it incorporate fundamental analysis?
A solid thesis helps you avoid overfit strategies that work only in a narrow market window.
Robustness Over Time
Once you understand the thesis, assess whether the strategy is robust over different time periods and market conditions. Many strategies may show good performance in short backtests but fail in real-world application.
• Does the strategy perform consistently over years, not just during favorable market conditions?
• How does it handle volatility spikes or tail events?
Look for strategies that have been tested across various market environments to avoid overfitting.
Performance Without Excessive Leverage
Evaluate the strategy’s advertised performance and determine if it relies heavily on leverage to achieve high returns. While leverage can enhance profits, it significantly increases risk.
• Does the strategy achieve results without requiring excessive leverage?
• Are slippage and commissions factored into performance metrics, or are the advertised returns inflated?
Be cautious of strategies claiming high annual growth rates, especially over 15%, without clearly accounting for real-world trading costs and risks.
Asymmetrical or Convex Payouts
Some traders prefer strategies with asymmetrical or convex payoffs, meaning small, consistent losses with the potential for large gains. These strategies are akin to insurance-like trades: they require accepting frequent small losses in exchange for the chance of a large payout during significant market events.
• Does the strategy offer tail-risk protection, similar to options strategies that thrive during market shocks?
• How does the strategy balance risk and reward over time?
If the strategy’s payouts are lopsided in a positive way, it might be worth considering for high-risk, high-reward traders.
Compare to Buy-and-Hold
Lastly, always compare the strategy’s performance to a simple buy-and-hold approach. If the strategy underperforms in the long term compared to simply holding the asset, it might not be worth the additional risk and complexity.
• If the strategy only took a few trades during backtesting, why not just buy and hold the asset instead?
• How does the strategy perform against a benchmark like the S&P 500 (SPY)?
Make sure the strategy adds value beyond what a passive investing approach would achieve.
