|
PureBytes Links
Trading Reference Links
|
6. What five letter word...
TREND
Is there any reason why Markowitz's Efficient Frontier cannot be applied
here to
obtain the optimal mix of several systems and multiple markets ?
> -----Original Message-----
> From: Mark Johnson [mailto:janitor@xxxxxxxxxxxx]
> Sent: Wednesday, April 16, 2008 11:24 AM
> To: omega-list@xxxxxxxxxx
> Subject: Position trading 100+ futures markets times 8 systems
>
> DANGER! THERE IS RISK OF LOSS IN FUTURES TRADING!!
>
> In email, Gary Fritz suggested that I begin a thread here,
> talking about the philosophy behind position-trading a
> mechanical system on more than 100 futures markets, using the
> same parameters in each market. Here goes.
>
> Trading lots of markets simultaneously out of the same
> account means you'll have lots of simultaneous positions.
> You hope to get some benefits of "diversification", such
> as: when one position zigs, another position zags, and the
> net result is a smoother ride. If you want to think of it
> this way, by trading 100 markets simultaneously, you are
> summing together 100 different equity curves from 100
> "market-systems" as Ralph Vince calls them.
> Your net result is the AVERAGE of the 100 different equity
> curves (times 100). And the average of the individual equity
> curves is, we hope!, much smoother than the individual curves
> themselves.
>
> They gave a Nobel Prize to Harry Markowitz who worked out a
> theory of diversification benefits in the 1950's.
> His book "Portfolio Selection" talks about it, in very
> down-to-earth terms, and I *strongly* recommend reading the
> book if you're going to make smooth-equity-curve-by-
> means-of-diversification one of your goals.
>
> The math boils down to this: you can increase returns and
> decrease "non-smoothness" (variance) by adding more traded
> markets to your system, as long as the correlation
> coefficient between (the new market-system's equity curve)
> and (the equity curves of the other systems) is small.
> Which, hallelujah and praise Buddah, happens to be the case
> in futures. Much more so than in stocks!
>
> The math becomes especially simple if you make a numerically
> convenient but wildly unrealistic assumption:
> that all the correlation coefficients are equal to zero.
> Occasionally you'll see an article in which someone blithely
> assumes the individual market-systems are "uncorrelated"
> (correlation equals zero). It ain't true in real life,
> amigo. It ain't true at all.
>
> But what does appear to be true, at least in my own research,
> is that the correlation coefficients between the equity
> curves of different markets traded with the same mechanical
> system, are Quite Low. They are Sufficiently Low. Low
> enough so you get SOME positive benefit by adding yet another
> market. Sure, you get less benefit than if the correlation
> had been Zero, but SOME benefit nevertheless. In fact, my
> research suggests to me a rather startling result:
>
> The optimum number of commodity markets to
> trade simultaneously with a mechanical system,
> is Infinity.
>
> I see that the more markets I add, the better and better the
> final results become. In fact, I chuckle with Bob Fulks that
> this approach could be called "Wildly Excessive Diversification."
>
> Applying the first principle of underwater demolition,
> >> "If some is good then more is better" <<
> I have chosen to increase the amount of diversification yet
> further, by trading several different mechanical systems
> simultaneously, each one of them on the enormous
> 100+ market portfolio. Again I find that the marginal
> utility of adding that last system and that last market, is positive.
>
> There are a couple of drawbacks however. First of all, it
> means the trader must manage several hundred simultaneous
> positions. Which requires software that can deal with
> multiple simultaneous systems trading large baskets of
> instruments. I don't know whether the current Tradestation
> can or can't do this; I'm using non-TS software at present.
> Generating orders for the next bar (I use daily bars myself)
> is a big production, since there are times when system B buys
> Crude Oil on the same day that system F sells Crude Oil.
> Perhaps at the same price (in which case you can net-out the
> orders), or perhaps at different prices. Getting the stops
> positioned and re-positioned is a bigger task than some
> software products can handle.
>
> Another drawback is: it requires a large account. The
> average risk I have on any one position in one market for one
> system, is around 0.05% of the account. Five one-hundredths
> of one percent. If stops were $1500 from entry, (which
> they're actually not, but it makes a simple example) then I'd
> be trading one contract per 3 million dollars of account
> equity. (Math:
> $1500 / 0.0005 = 3E6)
>
> A third drawback: This approach has always got a lot of
> simultaneous (small) positions, so it's always exposed to
> price shock risk, "Black Swans" as the press likes to say, in
> a lot more ways than other traders. If there's huge price
> shock in Crude Palm Oil, I'll get injured when most other
> traders won't.
> On the other hand, if there's a huge price move in an obscure
> market, and I happen to be on the RIGHT side of it (like the
> bull move in LME Aluminum Alloy in February 08), then I catch
> a windfall that few other traders do.
>
> I'll wrap up by offering a few points to ponder.
> As they say in academic papers, Suggestions For Further Research.
>
> 1. What is an appropriate measure of goodness, a
> quantification of desirability, for evaluating the trading
> results of a multi-system, multi-market approach?
>
> 2. How would YOU go about testing the hypothesis that adding
> more market-systems improves the trading results? (Or,
> equivalently, testing the NULL hypothesis that adding more
> market-systems makes no difference at all?)
>
> 3. If you absolutely HAD NO CHOICE and knew that you MUST
> build a software and hardware and infrastructure trading room
> so you could simultaneously trade 8 different systems, each
> one of them on 100 markets, what products would you buy and why?
>
> 4. Does it give you any additional comfort that the
> parameters of your mechanical system are not "over fitted",
> when you apply those parameters to
> 100+ different markets? Does this increase the
> ratio of (#trades / (#degrees of freedom consumed)) by a
> factor of 100, and if so, does it matter?
>
> 5. Since this approach trades all markets, it guarantees you
> will be trading next year's hottest market, the one everybody
> agrees was "best". It also guarantees you will be trading
> next year's absolutely worst market.
> Is this desirable? Undesirable? Neither?
>
> 6. What five-letter word, often used in discussions of
> trading methodology, is completely absent from this posting?
>
>
> Best wishes to all,
> Mark Johnson
> (who gets the O-List Digest, the next day)
>
> DANGER! THERE IS RISK OF LOSS IN FUTURES TRADING!!
>
>
|