Even beginning investors know that the basic lesson of stock trading is: diversification. It means that I do not buy just one title, but I buy more of them – and I am creating a portfolio.
Forex and futures traders do not usually keep this rule. And that’s a mistake. Let me tell you today why it’s important not to put all eggs in one basket.
Each strategy has its better and worse period. Moreover, markets are changing, and we never know for sure which strategy will be the best in the current conditions. Therefore, even a perfect backtest results, when we have practically no drawdowns in the history, does not necessarily mean that the strategy will be so profitable in real conditions. As I wrote last time – just backtest is not enough.
When the strategy itself is not enough, it is necessary to focus on a quality portfolio.
Let me show you how one strategy looks like compared to the well-built portfolio.
Equity of a single strategy (source: StrategyQuant)
Equity of portfolio (source: StrategyQuant)
You can see that the portfolio, in which there are 7 strategies, is complementary and has better results. Improvement is also achieved in real trading, where strategies are complementary to each other.
It is important that the strategies are not all the same, but they complementary.
Similarity of the strategies
A similarity of the strategies is measured with a so-called correlation. This simply tells us how much the strategies are similar. If the correlation is 0, they are completely different, if it is 1, they are the same and if it is -1, then they are mirrored.
On this chart, you can see the correlation of the strategies in the above-mentioned portfolio and you can see that most of them are really very different and suitably complemented. Each cell represents a correlation between two different strategies.
Strategy correlation (source: QuantAnalyzer)
I am preparing for you free ebook about automated trading, that will be soon available on our webpage, so stay tuned.