Systematic Trading research and development, with a flavour of Trend Following
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May 26th, 2011 · 2 Comments · Blog

Just a quick post to let you know that the blog will go into “hibernation mode” for roughly a month, as I am going travelling to very remote places for the next 4-5 weeks, most of which will be without internet access or even electricity… It will be an interesting “jump” into a “disconnected” world, which should hopefully bring me back refreshed and full of new ideas.

There will be no new posts and I will not be replying to emails or approving new comments. The State of Trend Following and Trend Following Wizards report for May will be delayed to the end of June – apologies for the inconvenience.

Correlation Thoughts

It is often said that “Diversification is the only free lunch on Wall Street”.

Adding a new instrument or system usually improves a portfolio’s risk/reward profile, thanks to the non-correlation of the new addition – with the improvement usually increasing when the correlation decreases.

I’ll leave you with this “Summer puzzle“:

Is it possible to add a strongly anti-correlated instrument to a portfolio, without improving either return or risk of the portfolio? If yes, how?
Note that to make this puzzle less obvious the new instrument should have positive average return and volatility/standard deviation both similar to that of the portfolio (with risk being defined as Max Drawdown, and strongly anti-correlated with Pearson coefficient < -0.8). Most readers will probably find the key to that puzzle fairly easily, but I still find it worth to ponder the answer, and the impact it can have on how to use correlation in system development. Without thinking about it, it seems fairly counter-intuitive. As an extra, deciding question, you can try and guess where I will be in the coming month... Hint: the main clue is in the picture above + the fact that this is a circumambulated mountain (rather than climbed). Feel free to send your submissions by email or comments. Nothing to win though... Until the end of June. Jez    

Picture credits: vitafluida via flickr (CC)
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