Concentrate To Create; Diversify To Protect

Diversify, Diversify, Diversify :

Protection of wealth over long term requires an investor to diversify in multiple asset classes. No single asset class can consistently give returns to the investor. Talk about investment choices and most people today would be constrained by Equities, Gold, Fixed Deposit and Real Estate. Even top wealth managers in the world like Harvard Endowment fund ultimately relies of these 4 asset classes for diversification and wealth protection.

Consider Algo strategies (aka, Algorithmic Trading Strategies, aka, Quantitative Trading Strategies) as an alternative asset vehicle of investment which has NO or very little correlation with traditional assets like Equities, Gold etc. An investment of 10-25% of your wealth portfolio to Algo trading over a long period of time, can give you that extra edge in wealth generation which traditional method of investment fails to give. For example, consider an Algo strategy which trades derivative products like futures based on market trends. The Algo strategy will be able to generate consistent returns in both bullish and bearish market irrespective of the market trends. Hence a 50% fall in Equities (like 2008) would cause a massive loss in your equities portfolio, but your Algo strategy portfolio might have a phenomenal run – Classical diversification.

Thoroughly back-tested rules :

Highly successful Algo trading strategies are built on patterns which are repeated in markets with very high probability of success. True hallmark of a successful Algo strategy lies in identifying these high probability rules. Hence, implementation of a thoroughly back- tested rule for trading gives you that extra edge over traditional methods of investing – by getting the odds in your favour. For example, consider a rule for trade entry and exit which has been successful 7 out of 10 times in the past. Now every-time this rule occurs in the future if a person bets all 10 times then he has a probability of about 70% (7 out of 10) to be successful with his trading pattern.

Systematic, Disciplined :

Human brains have two key components – IQ and EQ. IQ or the Intelligent Quotient is the part which helps a human being rationalize and make logical decision. For example a careful entry into a trade based on technical signals. The EQ or the emotional side of the brain tends to make the heart go heavy over the head. Hence, if for example the trade starts going against us, we become emotional about it and randomly decide to unwind the trade. Success in financial markets requires strict discipline and systematic approach. This is where Algo trading plays a big role as most of the rules, for example – rules for buying and selling of a stock is based on systematic rules and the computers can execute these rules in a very disciplined style repeatedly – day in and out. Hence the idea of becoming sentimental about a trade or taking random decision takes a back-seat.