A participant at Quantopian used gearing in a backtest to produce a back tested “return” of 40,000% + on a system run from 2002 to date. He was gearing up a stock momentum system.
When asked how the return was achieved he replies:
Where did the outperformance come from?
From gaming the strategy itself, of course. By making it an automated gambling machine.
I replied as follows:
I do not believe that gambling strategies have any place in an adaptive complex system. Probability may be a fine tool to analyse games of chance with fixed rules but adding a gambling approach to market timing seems to me to be adding one dubious approach to another.
In the long term momentum may be effective. In the short term I believe it has become less and less effective as a tool to time markets over the past 40 years. My analysis of future markets over the period certainly shows that trends have become less and less easy to profit from in a trading sense as market activity has increased.
To the extent that I am now wary of using momentum for my own trading and prefer to “earn” rather than speculate on a probabilistic approach.
To add extreme leverage to a method which may well anyway have seen its day seems unwise to say the least.