Exploring Correlation Forecasting Techniques in Financial Markets

Today, we delve into the nuances of systematic investing with Rob Carver, focusing on the concept of replication in trend-following strategies. The discussion contrasts different approaches to replication, highlighting the potential pitfalls of return-based methods that attempt to mimic established indices. We emphasize that simply increasing the number of markets in a portfolio may not lead to better diversification, as it could ultimately expose investors to similar risk factors. We also explore the implications of a recent paper from Newfound Research, which uses random data to challenge traditional views on replication effectiveness. With insights on factors influencing CTA performance and the importance of understanding true diversification, this conversation offers valuable perspectives for both investors and practitioners in the systematic trading space.

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Episode TimeStamps:

00:57 - What has caught our attention recently?

05:55 - Should trend followers lower their horizon?

09:26 - The AI CTA's are being tracked

10:37 - An economic Kayfabe

13:58 - Are interest rates approaching a Minsky moment?

18:44 - Industry performance update

20:33 - Q1, CryptoCaptainX3: How do you manage intraday adverse price movement risk while running a daily system?

25:43 - Q1.1 CryptoCaptainX3: How to manage overnight gap risk for futures instruments which trade only 6 hours a day?

26:13 - Q1.2 CryptoCaptainX3: Can you trade directional strategies but instead of using futures, use options. What are the pros and cons of this?

30:55 - Q2, Taylor: How do you think about position rebalancing, and the tradeoff between maintaining your desired risk allocation versus minimizing transaction cost?

34:22 - Q3, Richard: "Position Inertia", a method of avoiding frequent small trades by widening the target to 10% above and below the desired position. Have you considered varying this parameter depending on the estimated trading costs of the instrument?

36:01 - Q3.1 Richard: I currently use a rolling 10 year window of weekly returns to forecast correlations between futures instruments as you suggest in a blog post in 2020. Do you think there would be any value in applying an exponential smoothing to the correlation forecasts?

41:13 - Q4 Michael: How do you monitor that your systems are runnings normally intra-day, without checking the performance?

43:48 - Q5 Richard: How to dynamically allocate capital between different strategies in a live systematic system, given dozens of strategies, all with changing performance over time.

45:33 - Q6: Cloud: Are there any ways or optimizations to pick the right strategies and right instruments (profitable)?

47:38 - Is "less is more" applicable when it comes to market selection?

59:26 - The promises and pitfalls of replication strategies

01:13:30 - A mixed up narrative - do they truly replicate performance?

01:20:00 - What is up for next week?

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