Comparison of equity curves: DM and SF

-DM -SF

Date

Figure 2.9 Swiss franc and deutsche mark equity curves are highly correlated at 83 percent.

Rule 5: Risk Control, Money Management, and Portfolio Design 35

contract each of SF and DM, but your profits would have been $63,850 trading two contracts of DM and $57,388 trading two contracts of SF.

Note one important difference between the two cases. Since the two markets may have negative correlation from time to time, the draw­down for both SF and DM together may be in between trading two con­tracts of just DM or SF. For example, the drawdown for SF and DM in this case was -$10,186 versus -$22,375 for two DM contracts and -$9,950 for two SF contracts. Hence, the benefits of trading correlated markets are relatively small. Thus, it may be better to trade uncorrelated or weakly correlated markets in the same portfolio.

The benefits of adding usually unrelated markets to a portfolio can be illustrated by an example of trading the Swiss franc (SF), cotton (CT) and 10-year Treasury note (TY) in a single account, using the same dual moving average system as above. The paper profits from trading three SF contracts add up to $86,801 versus $85,683 for SF plus TY and CT. The equity curve for the two combinations is shown in Figure 2.10. The smoothness of the two curves can be compared by using linear regres­sion analysis to calculate the standard error (SE) of the daily equity

Equity Curve: 3SF vs SF+TY+CT

-3SF -SUM

Days (5/89-6/95)

Figure 2.10 Adding 10-year T-note (TY) and cotton to the portfolio trading just Swiss francs provides a smoother equity curve versus trading three SF contracts.

36 Principles of Trading System Design