Efficient Capital Allocation - A🧵
A lot of traders are looking to deploy multiple systems with opposing styles (trend following + vol selling) on same capital to enhance returns. The assumption is that with sufficient buffer, idle capital can take care of losses in one sys. 1/n
A lot of traders are looking to deploy multiple systems with opposing styles (trend following + vol selling) on same capital to enhance returns. The assumption is that with sufficient buffer, idle capital can take care of losses in one sys. 1/n
While some results may be generated from the other system. The risk from this comes in form of systems becoming highly correlated and leading to more than perceived DD from back tests. The traders can be better off if they perform following: 2/n
1- Understand if your returns are coming from different aspects of markets. This could be cross asset class or from different style (Trend/Mean rev/Vol selling etc) 3/n
2 - Perform a rolling correlation of your returns from both systems. Use different lookbacks in your analysis to identify when does your system come under stress and correlation either shoots up or breaks down. 4/n
3 - You're assuming future correlations to hold for your combined system to make money. Stress this assumption. A Monte Carlo simulation is easiest and quickest way to do so. 5/n
Lastly - appreciate the fact that backtesting is one data point from historical possibilities. Go in with expecting pretty different result than your backtest shows. Be aware of Ergodicity in your returns. n/n
I meant - lack of Ergodicity in expected returns by being aware of it.
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