It's not uncommon to see advertisements for trading strategies claiming more than 90% accuracy or showing an equity curve chart that looks like a smooth diagonal line. People often believe that such holy grail trading methods must be very difficult to discover. In fact, they are incredibly easy to discover. For example, the (unwise) strategy of buying on a 5% dip and selling on a 5% rally will perfectly identify market turning points, provided that the person selling this holy grail uses the right period of historical data and the right stock, currency or futures contract to backtest on. Any indicator can be made to look like a holy grail, given adequate time to select the most favorable sample period and refine the strategy with just the right set of arbitrary rules.

There are a few tell-tale signs that a trading method is a "holy grail." Usually, the system vendor will advertise the frequency of winning trades and it will be impressive, often greater than 90%. If there is any sort of backtest report, it will be on only one market, such as cattle or Euros. There may be a different indicator for every possible market. Performance reports will always have impressive equity graphs that only move in two directions: up a little or up a lot. The method may even be advertised as a "holy grail."

While we don't have a very high opinion about the EMH for reasons noted here, we don't deny that markets can be partially efficient from time to time. For example, when there are good reasons to go long some instrument, the smart money will begin to buy in. This drives the price up and forces others to get in at a less attractive price. This doesn't make the trade entirely unprofitable to latecomers though, because the market participants that get in early are few in number and prudent enough not to plunge into the position with huge sums of money.

What happens when some particular indicator starts to work perfectly? Unlike individual trades where a few lone hands get in ahead of the crowd with small, safe bets, perfect systems inevitably create the conditions of their own demise. Suppose that some indicator has had nearly perfect accuracy for a while. As more fledgeling technical analysts begin to trade on this indicator they will arbitrage the effectiveness out of the indicator, frequently going broke in the process. When they do, their losses become the winnings of other traders, many of whom may have been using methods that were almost exactly opposed to the "perfect" indicator.

While systems and indicators with nearly perfect accuracy have managed to capture the attention of many, imperfect indicators are the ones that capture the greatest profits. If a trading strategy results in losing trades more than 60% of the time, the overwhelming majority of traders will avoid such a strategy like the plague. No matter how profitable the method is over the long run, short run volatility of returns keeps the majority of aspiring traders away. For those that can look past the short term up and down movement in their equity curve, these sorts of methods are a long term gold mine. The profitability of these methods is never arbitraged away, because too few traders are willing to experience such variability in returns.

No trading method is perfect and none ever will be. Some, however, are far better than others. The critical ingredient is to find a method that is profitable in the long run but discouraging in the short run. This ensures that the population of traders using this method will never become overcrowded. Avoid the holy grails. Trade iSigma.