Read on for our test results – using our State of Trend Following systems – on how global diversification can boost trading performance, compared to a more standard diversification approach.
Is classic diversification enough?
The rise of correlation in developed markets has reduced the advantage offered from “classic diversification”. To regain the benefits of the proverbial “free lunch”, traders now have to seek exotic markets and access global diversification.
In this article, we explore the advantages of global diversification over a more standard approach consisting of a portfolio composed of mainstream markets from different sectors.
Intuitively, it makes sense that adding more exotic markets provides more opportunities to catch big trends, with less inter-market correlations. But we wanted to test and quantify the potential performance improvements of trading more exotic markets.
Global vs Classic Diversification: Exotic Markets Impact Test
Using the same systems as in the Wisdom State of Trend Following report, we compare the performance over two different diversified portfolios:
- “Standard” portfolio – using “classic” diversification
- Global diversified portfolio – including some exotic markets
For the purpose of this test, we defined an exotic market using three criteria:
- Remote/“exotic” exchanges or products (South African exchange or Brazilian Real)
- Alternative markets to the mainstream ones (Corn on the MATIF instead of the CME)
- Niche markets (like Milk or Lumber)
In order to avoid any portfolio selection bias we did not limit the test to two portfolios only. Instead, we selected a list of “standard” and “exotic” markets and developed a tool allowing us to draw at random from these lists, and form multiple portfolios.
Standard portfolios can only draw from the list of standard markets, whereas exotic portfolios can draw from both lists. Each portfolio contains the same number of overall instruments with the same number of instruments per sector.
The details of markets and portfolio composition can be found further below, after the test results.
How Exotic Portfolios Out-Perform Standard Ones: The Test Results
We ran the Wisdom State of Trend Following systems over 500 different portfolios and collated the performance stats for each test run.
Below is a chart showing all of the 500 simulations based on their respective CAGR and Max Drawdown. Each dot represents a specific run. The green cluster shows portfolio including exotic markets, while the red one only includes “standard” markets.
Better runs are located on the top-left (and conversely worst ones in the bottom-right corner). Increased CAGR and reduced Max Drawdown make it quite apparent that exotic markets bring in a boost in performance.
Further below are summary stats for both groups of tests:
CAGR |
Average | Min | Max |
|---|---|---|---|
| Standard | 6.26% | 4.38% | 8.45% |
| Exotic | 13.8% | 9.15% | 17.67% |
MAR |
Average | Min | Max |
|---|---|---|---|
| Standard | 0.21 | 0.15 | 0.29 |
| Exotic | 0.61 | 0.34 | 0.99 |
Sharpe |
Average | Min | Max |
|---|---|---|---|
| Standard | 0.17 | 0.07 | 0.28 |
| Exotic | 0.53 | 0.3 | 0.78 |
MaxDD |
Average | Min | Max |
|---|---|---|---|
| Standard | 29.90% | 23.80% | 36.50% |
| Exotic | 22.20% | 16.50% | 32.90% |
Performance is increased by a significant margin across all 4 metrics.
Test Details
The systems (and system allocation) used in the test are identical to those used for the Wisdom State of Trend Following.
A large list of markets were then selected and classified as exotic or standard, as well as by sector. These markets were then fed to the random portfolio generator, constrained with specific numbers of instruments per sector – to make the portfolios relevant for comparison, in the context of diversification:
| Sector | Standard | Exotic? |
|---|---|---|
| Currencies | 4 | 2+2* |
| Energies | 2 | 1+1* |
| Equity Indices | 4 | 2+2* |
| Grains | 4 | 2+2* |
| Long Rates | 3 | 1+2* |
| Meats | 2 | 2+0* |
| Metals | 3 | 1+2* |
| Short Rates | 2 | 1+1* |
| Softs | 3 | 1+2* |
The “starred” number is the number of exotic markets. For example, the metals sector always contains 3 different markets and in the case of exotic portfolios, 2 of these markets are exotic, with the remaining 1 being standard.
Below is the list of all markets selected for the test:
| Currencies | Exchange | Exotic? |
|---|---|---|
| Australian Dollar | CME | N |
| British Pound | CME | N |
| Canadian Dollar | CME | N |
| Euro | CME | N |
| Japanese Yen | CME | N |
| US Dollar Index | ICE | N |
| Brazilian Real | CME | Y |
| Euro / Japanese Yen | CME | Y |
| Indian Rupee | CME | Y |
| Korean Won | KRX (Kofex) | Y |
| New Zealand Dollar | CME | Y |
| Energies | Exchange | Exotic? |
|---|---|---|
| Gasoline (RBOB) | NYMEX | N |
| Light Sweet Crude Oil (WTI) E-mini | NYMEX | N |
| Natural Gas (Henry Hub) E-mini | NYMEX | N |
| Brent Crude Oil | ICE EUR (IPE) | Y |
| Gas Oil | ICE EUR (IPE) | Y |
| Gas Oil | TOCOM | Y |
| Gasoline | TOCOM | Y |
| Kerosene | TOCOM | Y |
| Metals | Exchange | Exotic? |
|---|---|---|
| Copper | CME (NYMEX) | N |
| Gold | CME (COMEX) | N |
| Palladium | CME (NYMEX) | N |
| Silver | CME (COMEX) | N |
| Gold | TOCOM | Y |
| Palladium | TOCOM | Y |
| Silver | TOCOM | Y |
| Meats | Exchange | Exotic? |
|---|---|---|
| Cattle Feeder | CME | N |
| Live Cattle | CME | N |
| Short Rates | Exchange | Exotic? |
|---|---|---|
| Euribor 3-month | EURONEXT (LIFFE) | N |
| Fed Funds | CME (CBOT) | N |
| 90-Day NZ Bank Bills | ASX (SFE-NZFE) | Y |
| Australian Bank Bills (90 day) | ASX (SFE) | Y |
| Equity Indices | Exchange | Exotic? |
|---|---|---|
| Dax index | EUREX | N |
| Dow Jones | CME | N |
| Mini Russell 1000 index | ICE US (NYFE) | N |
| Nasdaq 100 | CME | N |
| S&P 500 | CME | N |
| FTSE Xinhua China A50 index | SGX | Y |
| Hang Seng index mini | HKEx | Y |
| MSCI Singapore Stock index | SGX | Y |
| TOPIX index | TSE | Y |
| Grains | Exchange | Exotic? |
|---|---|---|
| Corn | CME (CBOT) | N |
| Oats | CME (CBOT) | N |
| Rice Rough | CME (CBOT) | N |
| Soybeans | CME (CBOT) | N |
| Wheat | KCBT | N |
| Wheat | CME (CBOT) | N |
| Azuki Beans | TOCOM | Y |
| Corn | NYSE Liffe (MATIF) | Y |
| Crude Palm Oil | BMD (MDEX) | Y |
| Milling Wheat | EURONEXT (MATIF) | Y |
| Rapeseed | NYSE Liffe (MATIF) | Y |
| Yellow Maize | SAFEX | Y |
| Long Rates | Exchange | Exotic? |
|---|---|---|
| Euro German Bund | EUREX | N |
| Japanese 10-Year Govt Bond | SGX | N |
| U.S. T-Bonds-30 Yr. | CME (CBOT) | N |
| US T-Notes 5-Year | CME (CBOT) | N |
| Australian Govt Bond | ASX (SFE) | Y |
| Canadian 10-Year Govt Bond | MX | Y |
| Swiss 10-Year Govt Bond | EUREX | Y |
| Softs | Exchange | Exotic? |
|---|---|---|
| Cocoa | ICE US (NYBOT-CSCE) | N |
| Coffee | ICE US (NYBOT-CSCE) | N |
| Cotton (#2) | ICE US (NYBOT-NYCE) | N |
| Robusta Coffee | NYSE Liffe (LIFFE) | Y |
| Sugar (#11) | ICE US (NYBOT-CSCE) | N |
| Cocoa | NYSE Liffe (LIFFE) | Y |
| Lumber | CME | Y |
| Milk (Class III) | CME | Y |
| Rubber | TOCOM | Y |
Boost your trading opportunities: Access more Exotic Markets
At Wisdom Trading, we strive to take your trading further. One way we do this is by expanding the frontiers of your trading universe. We offer one of the widest product offerings in the industry with access to over 300 markets on 30+ global exchanges.
Take your trading truly global: get in touch today to discuss how exotic diversification can boost your trading performance. We’ll be happy to discuss portfolio selection and recommended trading capital, specific markets coverage, or more specific system performance over different globally diversified portfolios.
Disclaimer
Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. in fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program.
One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results.
