In Search of Diversification by Selecting Strategy Parameters

Diversification is one of the most important tools for a systematic trader. This article will dive into the diversification possibilities of one simple strategy via different parameters. The article will both discuss the theoretical foundations and apply these to a real-world strategy under realistic assumptions about commissions, spreads and roll costs.


In Search of Diver­si­fi­ca­tion by Select­ing Strat­e­gy Para­me­ters (PDF, 13 pages, 3.3 MB)

The fig­ures below are the inter­ac­tive ver­sions of the fig­ures in the arti­cle, in the arti­cle’s order and under the arti­cle’s num­bers. Hov­er a series for its val­ues, drag across a chart to zoom and dou­ble-click to reset, and click a leg­end entry to hide or iso­late a series.


Fig­ure 1. Rel­a­tive port­fo­lio risk reduc­tion as a func­tion of strat­e­gy cor­re­la­tion. The two strate­gies are com­bined by putting 50% of the cap­i­tal in each of them.

Fig­ure 2. Num­ber of trade­able instru­ments over time. An instru­ment is clas­si­fied as trade­able if it sat­is­fies mar­ket data and liq­uid­i­ty con­straints. Smoothed for read­abil­i­ty.

Fig­ure 3. Look­back peri­od from 20 to 350 in steps of 5 of the cross-sec­tion­al momen­tum strat­e­gy and the cor­re­spond­ing Sharpe ratios. The Sharpe ratio is cal­cu­lat­ed with­out a risk free rate but includes all trad­ing costs.

Fig­ure 4. Equi­ty curve and Draw­down of best cross-sec­tion­al momen­tum strat­e­gy with look­back s=215. No com­pound­ing, start­ing cap­i­tal is 1 and risk tar­get 25%.

Fig­ure 5. Cor­re­la­tions between returns of cross-sec­tion­al momen­tum with look­back peri­ods s from 20 to 350 in steps of 5.

Fig­ure 6. Equi­ty curve and Draw­down of cross-sec­tion­al momen­tum strate­gies with a mix of look­back peri­ods. No com­pound­ing, start­ing cap­i­tal is 1 and risk tar­get 25%.

Fig­ure 7. Cor­re­la­tions between cross-sec­tion­al strat­e­gy returns with a mix of look­back peri­ods.

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