018 - The Trading Think Tank - Diversification: How Many Markets & Systems do I Need to Trade?

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The Trading Think Tank Series - Episode 1: How Important is Market & System Diversification in Trend Following?

If you have questions, all the answers are here! In this first episode of a new series we are calling the 'Trading Think Tank' we sit down with a panel of experts and really deep-dive a single topic. In this show it's all things diversification. What do we really mean by diversification anyway? How many markets do we need to trade? If 'more is better', why exactly is that? What is the relative value of diversifying across markets (such as stocks, bonds, currencies, commodities) versus diversifying across strategies (having multiple models of different types, time-frames or parameters)? Can a basket of stocks be 'diversified' or is the risk of their auto-correlation too high, particularly in an extreme event (the one we really care about that can send us broke)? How much capital is required if one wants to trade a diversified range of futures contracts? Are there alternatives, such as trading CFD's? Is it all too complex? Should we overlay volatility smoothing techniques into our models?

In this episode, literally jam-packed with actionable intel, Rich and Simon are joined by Moritz Seibert and Jerry Parker to discuss all of this in detail in the context of trend following.

Here are a couple of the key points:

  • Trading multiple markets can dramatically increase opportunities (particularly in capturing outliers) and reduce risks
  • We cover correlation between markets, and ways to break it down
  • Trading more markets doesn't mean diluting returns, we talk about how it's possible to in fact boost returns by focusing more heavily on the substantive moves that really make a difference
  • We cover ways to trade many different commodity markets without a huge capital base
  • Trading too few markets can lead to over-fitting and over-trading, since we focus more on the noise and less on the signal
  • It's easier to catch a big winner, than build a new trading strategy, so don't miss out on them. Optimise trading outcomes by broadening your exposure to different markets and opportunities
  • Market, strategy and time-frame diversification are the biggest free lunches around, make sure you get your calories before going into the wild

Survival in the markets means managing risks and maximising opportunities in every way you can. It's imperative to get the basics right first and build from there. By diversifying one's portfolio through various trading systems, as well as trading as many markets as possible, traders (particularly trend followers) can enhance their chances of success and reduce the impact of market correlations. By broadening their scope and utilizing different systems, traders can navigate market uncertainties more effectively. Furthermore, the conversation underscores the need for strategic capital allocation based on signals rather than predictions. This approach allows traders to adapt to market conditions dynamically and optimize their trading activities. By trading a wide range of markets and systems, traders can minimize hindsight and selection biases, leading to a more robust and adaptive trading strategy.

This video I found on YouTube is a great summary of determining capital required for diversified trend following in the futures markets: https://www.youtube.com/watch?v=CkV_H1TkcTA

Please share the show with someone and help us get the word out there!


Get in touch with us:

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