Trading Time Horizon: Why Quarterly Thinking Is a Trap for Trend Following Traders

“Jim DiMaria learned an important trading principle in the less lucrative arena of baseball statistics: The players who score the most runs are home run hitters, not those with consistent batting records. It’s the same with trading, DiMaria says. Consistency is something to strive for, but it’s not always optimal. Trading is a waiting game. You sit and wait and make a lot of money all at once. The profits tend to come in bunches. The secret is to go sideways between the home runs, not lose too much between them.”
Jim DiMaria

Why is basing your time horizon on quarters such a big mistake? The preoccupation that so many people have with twelve month returns is not smart trading. Top traders could not care less about twelve month returns, so why must you? The prime objective of top traders worldwide is to make money.

Quarters do not predict: Top traders know that focusing on quarterly objectives has nothing to do with success since that would assume you can control how much you make. Does anyone believe they can control how much they make? Quarterly performance reporting is nothing more than another way to mislead yourself pretending you can predict the market or shoot for profit targets.

Quarters are not real: They are artificial start and stop points. You are bombarded by references to quarterly performance numbers from almost every media outlet right? Most people focus on their portfolios from a quarterly perspective only. Why? Because the perspective may not be real, but it is easy, and most people prefer to go through life mindlessly. However, to properly evaluate any trading style a rolling 36 month window must be employed at a minimum. For example, say your trading system had little performance gain for the last 3 months of the year, but since trend following is long term in nature, it explodes with profit in the first month of the new year. With quarterly reporting you would look at this system as having a bad fourth quarter and a good first quarter. How does this interpretation help you? It does not.

Ponder what Jim DiMaria said above. Home runs may not feel easy or safe, but what is your alternative? You can either trade aggressively putting yourself in position to get rich or you can give your money to a mutual fund and buy and hope. DiMaria is really talking about being trapped in the quarterly performance cycle spin. You can worry about meeting some artificial time objective or you can be a home run hitter and take what the market gives no matter when it arrives.

Why the 36-Month Minimum Window Matters

DiMaria’s baseball analogy is the probability argument applied to time horizons. The home run hitter has a lower batting average than the contact hitter. Over 100 at-bats, the contact hitter will have more hits. Over a season, the home run hitter will have more runs batted in and more total bases. The correct metric for evaluating which approach is more valuable depends entirely on the time horizon and the objective. Quarterly performance evaluation is the equivalent of judging the home run hitter’s value by their batting average in any given week. The sample is too small and the metric is wrong.

Trend following’s profit distribution, as DiMaria describes, is lumpy. The system is flat or slightly negative for extended periods and then captures large directional moves that produce returns measured in multiples of the preceding flat period. A rolling quarter that captures only the flat period will show poor performance. A rolling quarter that captures only the large move will show spectacular performance. Neither tells you anything useful about the system’s long-run expected value. The rolling 36-month window is the minimum sample needed to span at least one complete cycle of flat and trending market conditions and produce a meaningful assessment of what the system actually does.

The quarterly performance industry exists because institutional clients demand quarterly reporting, institutional consultants provide quarterly benchmarking, and institutional managers are evaluated and hired or fired on quarterly results. This creates a systemic bias toward approaches that look good over three-month periods, which means approaches that are smooth and consistent rather than lumpy and trend-dependent. The smoothest approaches are often the most fragile, because smoothness in a probabilistic environment typically indicates hidden risk rather than genuine risk reduction. LTCM was smooth for four years. The smoothness ended catastrophically because it reflected a convergent strategy that had not yet encountered its failure regime.

Taking what the market gives, when it arrives, regardless of the calendar quarter in which it arrives, is the complete description of how trend following generates its long-run returns. The market does not schedule its major trends to fit quarterly reporting windows. A trend that begins in November and ends in February spans two calendar quarters. The Q4 looks bad. The Q1 looks good. Neither representation is meaningful. The full trend is the relevant unit of analysis, and the full trend does not fit in a quarter.