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Building Algorithmic Trading Systems: A Trader's Journey From Data Mining to Monte Carlo Simulation to Live Trading, + Website by Kevin J. Davey

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CHAPTER 15 Diversification

As you progress through the trading system development process numerous times, you’ll start to realize that you have an algorithmic strategy factory on your hands. Raw material comes in the door as strategy ideas for entry and exit. Machines, such as limited testing, walk-forward testing, and Monte Carlo simulation, work on your ideas and either shape it into a better product, or tear it to shreds. At the end of your factory, you end up with trading systems you can trade or garbage destined for the scrap heap. If you do this over and over, you’ll create a lot of garbage, but you’ll also have a stack of strategies to trade. That’s where diversification can be a big contributor.

I’m sure you’ve heard the old saw, “Put your eggs in one basket, then watch that basket!” In trading, this would be analogous to finding one trading system (the basket) and then putting all your money (eggs) into it. That is great if it works. I’m sure there are traders out there who concentrate on trading one system. I’m not one of them, though, and I do not recommend that you try to be one either. Why not? Well, the simple fact is that trading systems fail, and very few, if any, trading systems last forever. In addition, all trading systems go through drawdowns, and sometimes they recover and sometimes they don’t. Do you really want your money tied to the fortunes (or misfortunes) of one trading strategy? I sure don’t!

To get around this issue, I take the opposite approach ...

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