Along with seemingly every other person on the planet I headed out last weekend to view the much anticipated Avengers movie. While I wasn’t excited enough to don my Captain America suit and shield, I did convince the wife to join me in the superhero revelry. To the movie’s credit she enjoyed the storyline and more importantly the execution – and that’s saying something given that she’s eight months pregnant.
While my $20 “investment” turned out to be money well spent, I also came away from the blockbuster with a few trading related lessons in tow. The overwhelming success of The Avengers is due in large part to the diversification embedded in the story. Rather than only appealing to fans of the Hulk, Iron Man, or Thor, the movie targets all of them along with the remaining heroes simultaneously. If the Captain America fans don’t show up, so what? There are five other superheros beckoning their acolytes to the theaters to partake in the action. The inherent diversification targets a much broader demographic than had the movie been centered around a single hero.
While there are many forms of diversification in the financial markets, some of which I’ve touched on here, here, and here, the one with perhaps the most relevance to the theme laid out by The Avengers is strategy diversification. The tactic highlights the appeal of running multiple, somewhat uncorrelated strategies simultaneously. Remember each strategy exhibits teeter-totter like performance, alternating between periods of out- and under-performance. Mean reversion strategies shine when the market is range-bound, yet inflict losses when strong trending conditions emerge. Trend-following strategies are essentially the opposite, yielding profits in trending environments and losses in range-bound markets.
Traders looking to improve the results of their market neutral strategies like condors and butterflies might consider running trending strategies alongside them. This hybrid approach can often smooth out the month to month swings in PnL. Think of it this way, when the condor is suffering due to a strong directional move in the market, the trending strategy should be shining.
Keep in mind one can’t simply cobble together two crappy strategies and expect magic to happen. If both strategies yield profits independently then the combination of the two has a much better chance of succeeding.
The proper implementation of strategy diversification enhances one’s ability to generate profits in all market environments. Though they won’t capture as many profits as a trader only employing trending strategies in a strong directional market, they also won’t incur near as many losses when mean reversion returns to rule the market.
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