Adrian Reid explains how to combine multiple low-exposure trading systems into an allocated portfolio. He argues that to achieve true diversification these systems must generate signals at different times—via different markets, time frames, or directions—and recommends checking correlations to avoid simultaneous exposure that negates diversification.
If you have lots of systems in your capital allocation that have a very low exposure, they may or may not combine together well. If they're a very selective mean reversion system, for example, typically has low exposure and it takes a bunch of trades in one quick succession and then it goes to cash and then waits until there's a panic and it takes another bunch of trades, but most of the time it's sitting in cash. If you're going to combine many systems like that together, for it to combine effectively, they need to be based on different signals that happen at different times. Otherwise when you add them together, they can have exposure at exactly the same time and cash at exactly the same time. They won't really be giving you diversification. How would you get multiple low exposure, high risk adjusted return systems combined into a portfolio where they taking trades at different times? The key is to make sure the systems are quite different. Different markets, different time frames, different directions. And then if all else fails, check the correlation and make sure that they're low. So it's actually not really a problem if you have two systems that are exposed at exactly the same time or very similar times. When you do the capital allocation, you'll see that it's not efficient to have both in your portfolio because you'll be hitting your maximum exposure at a portfolio level because those two systems are spiking at the same time. So it will become obvious pretty quickly.
