Date 2/2/88-7/10/95

Figure 6.10 Case 6 combined equity curve for case 1 plus case 5.

You should not underestimate the potential difficulties caused by positive covariance. Figure 6.11 shows the effect of combining two DM systems with positive covariance. The usual rules for combining variance of two independent systems predicted a standard error of $5,430. The actual calculated SE was $6,935, about 28 percent greater. The two sys­tems have positive covariance because they tend to make (or lose) money at the same time, at least some of the time. Figure 6.11 shows lines one standard error on either side of the best fit line. These SE lines include most, but not all, of the points of the joint equity curves. The points that lie outside the SE bands occur when both systems "reinforce" each other, when they make money at the same time. Thus, combining sys­tems with positive covariance will increase SE and reduce smoothness. Now add the complication that we do not know how covariances will change in the future. Therefore, improvements in smoothness may not result from simply adding different systems trading the same market.

One popular prescription for smoothing the equity curve is diversi­fication through trading multiple markets. The equity curve for the cot­ton (CT) market, using the 65sma-3cc system from February 22, 1988,

192 Equity Curve Analysis