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Mark, great post.
Looking at your questions - surely you analyse your portfolio
as a single system and apply whatever money management that suits? The
problem I found for a 10 cross fx portfolio was accurately working out
the Max Intraday DD across the portfolio as using daily bars you just get
a Max IDD but it doesn't say what time of day - the worst case scenario of
adding up all Max IDD on any given day has proved wildly inaccurate. Max IDD's
have been about a quarter of the worst case we provided for (so far).
The smoother ride you mentioned works a treat.
As regards managing your 100 system/contract portfolio, provided TS
carry the data why not put it on TS and have it autotraded? - If the data
is available but the contracts to trade (like european stock index/bond)
in auto then you could hook up one of the linking products between TS and IB
or another broker. Using a dll and excel you can keep track of your
total positions for all markets - it is a pain to do for fx as
the lot size is not yet configurable in TS but futures should be easier.
There's also a cheap and cheerful Portfolio management product from TS Support
which can also do analysis and run RT or the expensive Rina who have
or are bringing out a new product to update PortfolioStream.
As regards always being in the hottest markets. Surely its more important
to be on the right side of a market whether its hot or cold?
Wednesday, April 16, 2008, 4:24:06 PM, you wrote:
MJ> DANGER! THERE IS RISK OF LOSS IN FUTURES TRADING!!
MJ> In email, Gary Fritz suggested that I begin a thread here,
MJ> talking about the philosophy behind position-trading a
MJ> mechanical system on more than 100 futures markets, using
MJ> the same parameters in each market. Here goes.
MJ> Trading lots of markets simultaneously out of the same
MJ> account means you'll have lots of simultaneous positions.
MJ> You hope to get some benefits of "diversification", such
MJ> as: when one position zigs, another position zags, and
MJ> the net result is a smoother ride. If you want to think
MJ> of it this way, by trading 100 markets simultaneously,
MJ> you are summing together 100 different equity curves
MJ> from 100 "market-systems" as Ralph Vince calls them.
MJ> Your net result is the AVERAGE of the 100 different
MJ> equity curves (times 100). And the average of the
MJ> individual equity curves is, we hope!, much smoother
MJ> than the individual curves themselves.
MJ> They gave a Nobel Prize to Harry Markowitz who worked
MJ> out a theory of diversification benefits in the 1950's.
MJ> His book "Portfolio Selection" talks about it, in very
MJ> down-to-earth terms, and I *strongly* recommend reading
MJ> the book if you're going to make smooth-equity-curve-by-
MJ> means-of-diversification one of your goals.
MJ> The math boils down to this: you can increase returns
MJ> and decrease "non-smoothness" (variance) by adding more
MJ> traded markets to your system, as long as the correlation
MJ> coefficient between (the new market-system's equity curve)
MJ> and (the equity curves of the other systems) is small.
MJ> Which, hallelujah and praise Buddah, happens to be the
MJ> case in futures. Much more so than in stocks!
MJ> The math becomes especially simple if you make a
MJ> numerically convenient but wildly unrealistic assumption:
MJ> that all the correlation coefficients are equal to zero.
MJ> Occasionally you'll see an article in which someone
MJ> blithely assumes the individual market-systems are
MJ> "uncorrelated" (correlation equals zero). It ain't
MJ> true in real life, amigo. It ain't true at all.
MJ> But what does appear to be true, at least in my own
MJ> research, is that the correlation coefficients between
MJ> the equity curves of different markets traded with the
MJ> same mechanical system, are Quite Low. They are
MJ> Sufficiently Low. Low enough so you get SOME positive
MJ> benefit by adding yet another market. Sure, you get
MJ> less benefit than if the correlation had been Zero,
MJ> but SOME benefit nevertheless. In fact, my research
MJ> suggests to me a rather startling result:
MJ> The optimum number of commodity markets to
MJ> trade simultaneously with a mechanical system,
MJ> is Infinity.
MJ> I see that the more markets I add, the better and
MJ> better the final results become. In fact, I chuckle
MJ> with Bob Fulks that this approach could be called
MJ> "Wildly Excessive Diversification."
MJ> Applying the first principle of underwater demolition,
MJ> >> "If some is good then more is better" <<
MJ> I have chosen to increase the amount of diversification
MJ> yet further, by trading several different mechanical
MJ> systems simultaneously, each one of them on the enormous
MJ> 100+ market portfolio. Again I find that the marginal
MJ> utility of adding that last system and that last
MJ> market, is positive.
MJ> There are a couple of drawbacks however. First of all,
MJ> it means the trader must manage several hundred
MJ> simultaneous positions. Which requires software that
MJ> can deal with multiple simultaneous systems trading
MJ> large baskets of instruments. I don't know whether
MJ> the current Tradestation can or can't do this; I'm
MJ> using non-TS software at present. Generating orders
MJ> for the next bar (I use daily bars myself) is a big
MJ> production, since there are times when system B
MJ> buys Crude Oil on the same day that system F sells
MJ> Crude Oil. Perhaps at the same price (in which case
MJ> you can net-out the orders), or perhaps at different
MJ> prices. Getting the stops positioned and re-positioned
MJ> is a bigger task than some software products can handle.
MJ> Another drawback is: it requires a large account. The
MJ> average risk I have on any one position in one market
MJ> for one system, is around 0.05% of the account. Five
MJ> one-hundredths of one percent. If stops were $1500
MJ> from entry, (which they're actually not, but it makes
MJ> a simple example) then I'd be trading one contract
MJ> per 3 million dollars of account equity. (Math:
MJ> $1500 / 0.0005 = 3E6)
MJ> A third drawback: This approach has always got a lot
MJ> of simultaneous (small) positions, so it's always
MJ> exposed to price shock risk, "Black Swans" as the
MJ> press likes to say, in a lot more ways than other
MJ> traders. If there's huge price shock in Crude Palm
MJ> Oil, I'll get injured when most other traders won't.
MJ> On the other hand, if there's a huge price move in
MJ> an obscure market, and I happen to be on the RIGHT
MJ> side of it (like the bull move in LME Aluminum Alloy
MJ> in February 08), then I catch a windfall that few
MJ> other traders do.
MJ> I'll wrap up by offering a few points to ponder.
MJ> As they say in academic papers, Suggestions For
MJ> Further Research.
MJ> 1. What is an appropriate measure of goodness,
MJ> a quantification of desirability, for evaluating
MJ> the trading results of a multi-system, multi-market
MJ> approach?
MJ> 2. How would YOU go about testing the hypothesis
MJ> that adding more market-systems improves the trading
MJ> results? (Or, equivalently, testing the NULL hypothesis
MJ> that adding more market-systems makes no difference
MJ> at all?)
MJ> 3. If you absolutely HAD NO CHOICE and knew that
MJ> you MUST build a software and hardware and infrastructure
MJ> trading room so you could simultaneously trade 8
MJ> different systems, each one of them on 100 markets, what
MJ> products would you buy and why?
MJ> 4. Does it give you any additional comfort that
MJ> the parameters of your mechanical system are not
MJ> "over fitted", when you apply those parameters to
MJ> 100+ different markets? Does this increase the
MJ> ratio of (#trades / (#degrees of freedom consumed))
MJ> by a factor of 100, and if so, does it matter?
MJ> 5. Since this approach trades all markets, it guarantees
MJ> you will be trading next year's hottest market, the one
MJ> everybody agrees was "best". It also guarantees you
MJ> will be trading next year's absolutely worst market.
MJ> Is this desirable? Undesirable? Neither?
MJ> 6. What five-letter word, often used in discussions
MJ> of trading methodology, is completely absent from this
MJ> posting?
MJ> Best wishes to all,
MJ> Mark Johnson
MJ> (who gets the O-List Digest, the next day)
MJ> DANGER! THERE IS RISK OF LOSS IN FUTURES TRADING!!
--
Best regards,
Michael michaelstewart@xxxxxxxxxxxxx
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