As I've mentioned in a few of my recent video's, now is a good to reflect, not only on life in general but also on your trading.
What could I have done better?
Am I missing anything?
Are there risks I'm not seeing?
The market will always keep you humble. It seemingly gives you a slap across the face if you're not paying attention.
So here's something that I have been thinking about but maybe have been approaching it from the wrong angle. And thanks to Corey Hoffstein over at investment firm I've had a jolt of common sense. I'll link to some of Corey's excellent research below.
To gain diversification when trading serially correlated instruments, specifically stocks, I have always used a variety of systems across markets and time frames. These include absolute trend, relative momentum, mean reversion, volatility day trading and I'm currently researching a market neutral strategy.
Yet within some of those specific strategies lurks another risk; signal luck.
Let me give you a basic example.
Here the Premium Portfolio is an aggressive monthly rotational momentum strategy. This means it assesses the market and individual stocks once a month and makes a decision whether to remain invested or head to cash.
That portfolio looked at the market at the close of February and decided it was time to go to cash. In hindsight a good decision. The portfolio is -2.5% YTD and in a drawdown circa 15%.
But what if we hadn't exited? What if the strategy had been slightly slower to react and left us holding the portfolio during this downdraft? Well, we'd be -16.6% YTD and in a drawdown of nearer -40%. Not pleasant.
And that's signal risk or timing luck as Corey calls it. Here's some further reading:
So what can we do to dilute signal luck?
From my immediate research we can do at least two things; vary the sensitivity of the rebalance and vary the sensitivity of the regime filter lookback.
For this exercise we'll compare the current monthly portfolio with a weekly variant that also has its regime filter halved, i.e. if the regime filter was set to 200 days in the monthly we'll adjust it to 100 on the weekly.