Weekly Systematic Trading Recap 03
Happy Monday, fellow traders.
Whether you're nursing a coffee or watching how the Bitcoin is flying…, here’s your weekly download of real trading “signals”.
Let’s get into it.
Towards Free Lunch – Quantifying Diversification
Principal Component Analysis (PCA): the only math worth doing on a weekend
Here's the thing: AI trading signals get all the love, but what if good old diversification still secretly holds the crown?
Context first: Diversification isn't just spreading bets around; it's about making sure your bets don't sync up and punch you at the same time. Enter PCA.
"Principal component analysis decomposes portfolios into various factors...if your first factor can already explain almost 100% of your portfolio, all the other factors have basically very little explanation power, meaning your portfolio is not very diversified."
So…..Using PCA to judge diversification is like having a polygraph for your portfolio. It tells you when your "diversification" is lying right to your face. Smooth-talkers get exposed quick.
Mean-Variance Optimization: the best way to shoot yourself in the foot
Optimizing your portfolio by Sharpe ratio is attractive until you realize you just optimized yourself into oblivion.
"When you optimize your portfolio, you're lowering diversification. Optimization might look good on paper, but out-of-sample it often collapses because your strategy becomes brittle to market conditions."
I think optimizers are like those crazy exes amazing short-term, destructive long-term. You either learn this lesson early, or you learn it painfully.
Line Your Own Pockets - Comparing Yourself to Others
Watching your P&L is toxic, even if it's pretty
Turns out obsessively checking your P&L mid-day is like obsessively checking Instagram only toxic and more expensive.
"During the trading day, you shouldn’t even look at your own P&L. It causes irrational emotions, whether you're up or down. It's as toxic as comparing your trading to someone on Twitter showing off a yacht."
I agree totally, Staring at your P&L is like weighing yourself after every meal pointless, obsessive, and it won't stop you from eating another slice of pizza (for real).
Brokers make your P&L sexy for a reason
Brokers aren’t stupid. They spend crazy amounts of time making your numbers look gorgeous so you'll stick around and trade more.
"Most brokerages spend so much time engineering the P&L number to look attractive... Robinhood throws confetti after trades, it’s all gamified to increase engagement."
Yup, your broker wants you checking your P&L constantly the way Netflix wants you binge-watching bad for you, great for them. Wake up.
Top Traders Unplugged - Trend Following and Drawdowns
Trend following: dead or just pretending?
Trend-following strategies are down, and suddenly everyone’s questioning if they’re broken. But are they?
"Drawdowns in trend-following strategies are statistically normal. A strategy with a 0.5 Sharpe over 25 years has an 80% chance of experiencing a 20% drawdown."
Complaining about trend-following drawdowns is like complaining about traffic on your commute annoying but completely expected.
Crowdedness isn't the issue; market structure is
People love blaming crowded trades, but here's the “kicker” (how ai likes to say): Trend-followers aren't nearly as crowded as people assume.
"CTA volumes as a percentage of overall futures volume have actually been decreasing over time."
Blaming "crowded trades" is just easier than admitting your strategy sucks. It's the trading equivalent of blaming your golf clubs.
That’s the week
This week was a reminder of trading’s quiet truths:
PCA exposes fake diversification.
Mean-variance optimization often equals strategic suicide.
Brokers love your obsession with pretty numbers.
Trend following isn't dead; it’s just your impatience that needs CPR.
Question of the week:
What’s a toxic trading habit you finally quit?