Yesterday, I noticed during my afternoon updates something that I keep mentioning: how true diversification is very hard to achieve in today’s fast paced, global electronic world. During the COVID crash in 2020 for about 6 weeks every stock market in the world was down. It was just a matter of how much.
Lately US stocks have been a bit shaky with spells of rallies here and there. Lots of events and economic policies out there to cause some concern. My sector etfs were down to 85% cash and I had no momentum etfs. What exposure I did have was hedged. Some of my positions were having a rough day.
But I remain serene in my view of my portfolio. Why? I keep pushing the portfolio towards what I call “Extreme Diversification”.
In order to have two positions perfectly diversified, you need a correlation of 0.00. If the coefficient is close to 1.00, the two items are highly correlated and if it’s -1.00, it would be inversely correlated like what happens with my hedges against the etf portfolio. They always go in opposite directions. You should be striving for coefficients close to 0.00. In other words. the two instruments can “do their own thing.” They don’t really care what the other is doing that day. This stabilizes the portfolio while allowing for profits to accrue, if your strategy has any positive expectancy at all.
While updating, I noticed what was happening in the Soybean market. With my overall portfolio down a bit yesterday, Soybeans had a huge day to mitigate losses in other positions, so I drilled down to the chart and took a look. Here’s what I saw:
What you are looking at is a $15,000 per contract move in one contract of Soybeans in the last two months. Did I know there was going to be a drought in Brazil during the winter crop season? Absolutely not. I never look at weather forecasts in Brazil. I wouldn’t even know why that would cause Soybean prices to skyrocket.
I do know that the trend following indicators put me into the position quite a while ago and I have enjoyed some nice profits along the way with this trade. This and other positions can become a sort of steady engine, creating uncorrelated profits where items like stock oriented investments are sideways or in some periods of weakness. This stabilizes the portfolio and helps me continue to be “Mr. Serenity”.🤠
Are there faster ways to run correlations on various securities and futures against each other? I can do with spreadsheets but it can eat up time :) . Great article.