20 Nov Does Diversification Mean More Profits?
Does Diversification Mean More Profits?
Nov. 20, 2013
Last Wednesday we looked at a decent USDJPY chart that would do pretty well if that were the only chart in your portfolio. The winning percentage was high (77%) and the return per year was solid (from 20% to over 200% annually).
The down side was the monthly success rate. If you had a never-touch, long-term account, there is no problem whatsoever trading just the USDJPY. However, if you are looking to quit your job and trade only this chart, making a monthly profit only 71% of the time might be a problem. Could you have no other income and still survive if you lost money four times a year? The winning months are fine but pulling money out for monthly expenses AND seeing the account go down can be a harrowing experience to say the least.
This week we look into what can be done about that.
My personal preference would be to trade only one chart, for a few reasons. One, less can go wrong. Trading several charts at once always opens you up to trading errors. Two, there is less to make you depressed. Taking a loss is one thing. But when you have 8 charts (or more) trading at once during a garbage market environment, the losses can come at you in waves. To see loss after loss after loss can be devastating, especially when you have to withdraw money out of this account at the end of the month.
Last, trading only one chart leads to intimate knowledge of your instrument. You learn what it’s like on holidays, or on Tuesdays, or every year in August. You learn how you might make intelligent tweaks to your chart, increasing profit and lessening drawdown. When you trade a bunch of charts, it’s nearly impossible to get to know them all. It feels like you’re losing the opportunity for deep knowledge, becoming a jack of all “trades” and master of none.
Nonetheless, let’s just add one chart to the mix. If two isn’t better than one, then there’s no point in even looking at adding any more.
Figuring out what to add, though, can be a project unto itself. Do you try to add an “uncorrelated” chart? Do you add a different time frame? Do you add a different Strategy? Do you add a different instrument altogether? These are all things to consider but, for this analysis, I’m doing none of that. I’m just picking another good-looking, similar chart that trades the same System on the same time frame: the GBPCHF.
Let’s see what happens (all numbers from 2003-2013 and I’m using a $10,000 account):
Total Profit USDJPY = $49,295
Total Profit USDJPY and GBPCHF = $110,926
Monthly Average Profit USDJPY = $394 (trading only 1 full lot)
Monthly Average Profit USDJPY and GBPCHF = $887 (only 1 full lot)
Worst Monthly Drawdown USDJPY only = -$2,085 (only once over $2,000 in 10 yr. period)
Worst Monthly Drawdown USDJPY+GBPCHF = -$2,596 (three times over $2,000 in 10 yr. period)
Most Consecutive Losing Months USDJPY = 3
Most Consecutive Losing Months USDJPY and GBPCHF = 5
To summarize, by adding one more currency, your monthly profit goes way up and your drawdown increases slightly. The problem is, even though you could still trade a $10,000 account comfortably both ways, the drawdown does increase in amount and frequency.
And what may be more important is that the consecutive losing months increases from 3 to 5. That would be rough if you had to pull money out each month.
But here’s the interesting thing. That aforementioned 5-month losing streak happens at the end of 2008. Despite that, the total profit for both currencies in 2008 for the whole year is $3,271, or 32%! You would have to weather almost half a year of losing, but you would still make 32% in one of the most disastrous years in our lifetimes!
That’s why trading for a living ultimately comes down to you and what you can handle. Two is better than one if you like money. Two is not better than one if you hate losing.
This is an important issue when deciding on your trade-for-a-living portfolio.
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HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.