The Puzzle Reassembled

Here we go again guys! In the second post we arrived to the point when too much was really too much (you can read the first post here)!

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After identifying the need to diversify, my portfolio grew very much in number of strategies and, at a certain point, it was no longer possible to keep it under control efficiently! There were simply too many things to analyze and to consider: what was working and what not was hidden in the monster I created…

I understood I had to rationalize the approach, first to find a way to decide which strategies should work and which not and then to position size them properly.

Working on a portfolio I concentrated on the shape of the equity line of each strategy, I simply considered its most recent performance. After deciding how often I had to look into the portfolio, I fed my System with daily profit/loss figures of all the strategies and, on the decided period I looked into those numbers. I do that on a monthly basis but it can be done also every week (even though I don’t think this would lead to particular additional benefits).

During the check, I look into a longer-term performance (something around 12 to 18 periods, months in my case) and a shorter term one (3 to 6 periods), both shall be positive and the shorter term must also show an average monthly profit higher than the longer term. This means we want performing strategies and strategies that show a momentum in their profits in the most recent period.

All the strategies passing this criterion are valid to trade during the coming month, all those which fail will stay in incubation.

To position size each strategy, again daily profit/loss figures are used: the worst day of each strategy is taken as Worst Case Scenario and used to calculate the number of contracts after deciding the percentage of risk to take.

The numbers we get can be further adjusted (reduced) considering the max drawdown of each strategy and correlations among systems.

The math related to this is not conceptually difficult but it requires some time and, once it has to be applied to a whole portfolio, it leads to an enormous calculating effort, with standard tools it could even take several hours to get some results.

We have also to consider that our basket should be widely backtested to identify the best set of parameters to use (risk%, long period, short period, etc.)… To do this titanic task we decided to developed a dedicated software: TITAN!

TITAN get as inputs the daily profit/loss of all the strategies, we can be set different testing parameters, and as an output we get the list of strategies to trade during next period and the number of contracts for each of them, as simple as that! But incredibly effective!

A portfolio is important in terms of content (good strategies) and maintenance (all the above operations), this is where I am today, now it’s your turn!

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The Engine is Flooded

During the first post dedicated to Portfolio Management we went through the approach to systematic trading and how simple it became once I met an eye-opener: no complicated mix of indicators but a simple set of rules with clear orders in certain moments of the day.

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I won my first championship back in 2005 using a 4 blocks EuroFX Strategy and I put the same in place, together with an intraday trend following system on Dax future, an intraday trend following system on FIB future and a countertrend strategy on miniSP500 to face the world cup in 2008.

A great year winning with 672% gave me the will to continue and I started competing also in 2009 using the same mix of strategies. I did believe in diversification and that mix convinced me I was duly diversified.

After a good start I fell back to breakeven around June, half a year was gone and I was back to 0%! Yet other traders were showing much better percentages on the leaders’ board, what happened?

I analyzed the situation and realized soon that, what I believed was a good diversification, was actually a poor one. Dax and FIB futures are highly correlated and the systems I used on those instruments were also built on extremely similar models, so actually I was doubling my exposure on that kind of index futures. No harm in 2008 when money was flowing in from any window but now that the scenario was tougher, losers were also knocking on the door and those 2 strategies were, most often, losing together!

Well, you might argue that I also had a countertrend strategy on another very important index future: the E-miniSP, but looking deeper into that as well I realized it was not really helping.

The 2 trend following strategies were based on filters looking for a volatility contraction on the days before as that helped enormously in getting a high level of efficiency in the breakouts. The miniSP strategy, looking for countertrend entries, was based on exactly opposite conditions! The only real filter in there was actually a requirement to have enough expansion on the range of the day before we took trades. It becomes obvious to understand that if miniSP500 had a very large range on one day, it would be very hard to see Dax or FIB on volatility contraction, all those markets are somehow correlated and if there is big move in one of them that move can normally be seen also on the others. The result of this was that the countertrend trades were often taken on days where the trend following strategies were not working at all and those did trade when the countertrend system was filtered. Not the best way to diversify…

In addition to all the above the EuroFX strategy, in 2009, started suffering a lot and produced losses instead of the desired gains.

The main problem was not only related to markets but also to the way I was limiting my development, even though highly effective as said, it could not cover all market conditions and 2009, coming after the storm of 2008, was a very strange year to face.

I understood I had to look deeper into the ways to develop and also look into different markets. In 2009, I immediately reacted adding a countertrend strategy on DAX in the earlier part of the day (if breakouts were effective starting after 11 am why not trade countertrend before that time?) and I also found out that market was showing a mean reverting behavior between 3 pm and 4 pm (Central European Time) so that I built sort of a scalping strategy into that time window.

Those actions helped taking me to victory with 115% and I also started diversifying much more on my main account outside the championship, strategies were added and new markets explored. This is an extremely important way to approach system development and in the Trading System Supremacy course I try to pass this concept, changing market on the strategies I develop as examples.

Things were getting better and better, more and more strategies were populating my portfolio (no you don’t need a large capital as some markets like Forex, CFDs or miniFutures offer the possibility to diversify also with a limited amount of money dedicated to trading) and then, in 2011, a drawdown arrived… Nothing unexpected, not pleasant, but normal. But it was not the drawdown the problem: I diversified so much …that I was no longer able to analyze my portfolio to understand what was working and what not! A new problem and a new opportunity, which you will discover in next post!

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In Union There is Strength

Today I’ll be talking about my trading story and it will be full of notions which will be extremely useful to you, a real must to build your personal trading business.

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I’m trading today with more than 80 active systems but what path did I go through to be where I am?

My story in undoubtedly a success story even though I consider my greatest achievement to be still in the market, considering I saw so many things, and also, unfortunately, many sad stories of people who got ruined by trading.

Everything started back in 2001 and when I was trading Covered Warrants. It was sort of a videogame, trading inefficiencies, I even wrote a guide on how to trade those instruments: that was my first actual teaching experience in the trading world!

Being an Engineer and knowing Covered Warrants inefficiencies could not last forever, I started looking into trading systems development and my first approach was a great disillusion! In spite of all my efforts applying common rules found on the internet (mixing as many indicators as possible…) I could not find anything that worked!

It was a friend of mine, a great Italian trader, Domenico Foti, who gave me the right tips to develop systems that worked and it was actually easier than I could imagine. Every strategy was composed by block of rules, the market was allow to develop its movement for some hours and then, inside a time window, orders were placed. These were breakout orders to buy or sell at significant levels such as, for example, the high or low of the day so far. Stop Loss or end of the day close were the exit orders. The filtering rules were mostly based on volatility compression or expansion such as limiting the expansion over the last 5 trading days.

I got the confirmation to be on the right way when in 2004 I participated to a seminar by Larry Williams. He was trading in a different way from me but showed the same approach in terms of systems built with blocks of rules.

In 2005 I tried the first challenge: the European championship, and I achieved a 61% return over the 3 months of competition winning with a single system trading EuroFX future. This strategy was built using 4 different blocks of rules and positions were held overnight.

That achievement pushed me further to try the World Contest and that’s what I did in 2008. Facing a more challenging target and aware that a single strategy could not be enough for such a contest, I decided, after trading in a discretionary way for one month, to use 4 different systems, the EuroFX one, an intraday trend following strategy on Dax Future, an intraday trend following system on the Italian FIB index future and a countertrend system on miniSP500 (I chose this market to trade that system being miniSP500 a market with a strong meanreverting behavior).

That was a great year and a great result: 672%, which lead me to the decision to try to win three years in a row as nobody ever did.

The most logical decision was to continue with the mix of strategies that allowed me to win in 2008… So was 2009 also a triumph? Not really…

Just to recap: with greater targets we need also greater diversification, to catch more opportunities and to better balance our trading. A single strategy (even though a great one) is not enough and we need a mix to diversify as much as possible. This is true for a one year long contest but even more if we want to trade for a living!

That was my first step and it was really successful, but then something happened, what?…

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See you soon,

Andrea

How to Best Manage your Trading Systems’ Portfolio

A few days ago I asked for help – I had a few questions as I finalized our brand new portfolio management training course.

The response was overwhelming – we had HUNDREDS of responses to our survey, and they have helped us refine our product so it covers EXACTLY what our readers need to know about managing portfolios of trading systems.

Reading your answers to the survey gave me a sense of incompleteness and anger, not towards you of course but towards that part of the trading industry that talks about misleading information, which is often also WRONG information… and wrong information in this business is very dangerous!

So I decided to react by clarifying some, often twisted, concepts. That’s why I just finished a report on some fundamental issues related to portfolio management, issues I believe are key for you all.

Here they are:


The 21 secrets to better manage your Portfolio of Trading Systems

  1. How should I consider the sum of the DD (Drawdown) of each TS (Trading System) compared to the portfolio DD? If I have 10 TS with max DD of 1% each, is it correct to say that the max DD for the portfolio is 10%?

The worst possible case is of course the sum of all Drawdowns, but that event is highly uncommon.

It all depends on when each TS Drawdown happen. If the strategies’ mix is built taking into account multiple DDs happening at the same time, the cooperation between strategies should result in a portfolio DD much better than then absolute Worst Case Scenario.

  1. Which portfolio would you build in case of markets with low volatility?

Trading Systems are developed to be able to tackle all market conditions, there are NO appropriate settings for low volatility markets phases because, if it were possible, the problem would then be to identify those phases. Generally speaking, it’s best to have a portfolio with maximum diversification so you can combine strategies that perform well in calm markets with others that perform better in high volatility periods. Of course each strategy, if properly built, should resist in all phases without extreme losses.

  1. To correctly manage a TS portfolio, do I need to know how to code?

It’s not needed but it helps. There are tools available you can use even if you can’t code and new code doesn’t have to be written. Of course if you learn the skill the job becomes easier.

  1. Which platforms/tools do I need to analyze and manage a TS portfolio?

You can start with an Excel sheet or use dedicated software. Amibroker has probably the best instrument but it’s not easy to learn. MultiCharts also has a tool to merge strategies, and even if it has some limitations, it offers a good planning tool. Unger Academy uses a proprietary software that, taking the TS daily profits as input, allows a detailed analysis of what could be the best mix to beat the markets.

  1. If I’m a discretionary trader, can I still apply the theory of portfolio management?

Yes, in theory… In practice, it’s hard to do so without objective data. Also consider that it’s implicitly harder to diversify a portfolio if you trade discretionally, because as human beings the amount of markets and TS that can be analyzed (and traded) in a certain amount of time is limited, hence decreasing the amount of effective diversification.

  1. Are there mechanical ways to stop a strategy that’s not performing as it should?

Yes, many ways! And no way… Common sense is what should prevail. Consider first you need to have A rule.

As an unrelated example, a rule to check your weight could be to go on a diet this week if you weigh 1 kg more than the previous week. This is a mix of common sense and a (more or less) mathematical formula, that have no scientific base but that does the trick. In trading it’s the same, THE rule to know when a TS should be stopped does not exist, but it’s solid common sense to have A numeric rule so you can make decisions based on that instead of gut feeling of the moment. In any case, rules are generally based on a degradation of performance with respect to the average system performance.

  1. Is there a minimum and maximum numbers of TS to have in a portfolio?

The minimum could be 2…

There’s no maximum except the one based on how much capital you have at your disposal to trade with.

  1. With maximum diversification, is it possible to have a portfolio that never loses money?

Unfortunately that’s very very difficult and shouldn’t become an objective (or you’ll get frustrated and lose your motivation). In trading it’s important to have a mid-long term view and thinking on short periods (weeks) it’s a way to proceed that is too random. The only valid rule is to never lose too much so that you can always keep playing!

  1. Is it possible to use an approach based on starting/stopping a TS based on its equity line?

It’s definitively possible and it’s one of the methods mostly used by many traders.

  1. Can I use different TS based on different logics on only one instrument?

Yes, absolutely. It’s the best way to proceed. But beware of how the platform works: don’t get confused with the correct amount of contracts which should be placed at the broker’s side. In many cases one strategy can be long, and the other short, so the net position for the broker is flat.

  1. Is it better to have one TS working on many instruments, or many TS on one instrument…

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