V.8:3 (83-89): Reducing profit variability from technical trading systems by Milton S. Boyd and B. Wade Brorsen

Reducing profit variability from technical trading systems by Milton S. Boyd and B. Wade Brorsen

Some technical traders spend a sizable portion of their time searching for the perfect trading system or the "optimal" parameters, hoping the newly discovered system will give them the highest-possible profit. However, research shows that some currently available popular trend-following systems have provided a reasonable profit, even when traded with conservative margin levels.

Unfortunately, the variance of the profits from these technical systems tends to be very high. In fact, the variance of the profits may be as important as the profit level itself. Since the variance from these systems is often very high in relation to the average profit level, technical traders may find these profits to be too variable to trade only one commodity at a time. Profit variance can be reduced by trading more commodities, because individual commodity profits tend to be uncorrelated. However, research also shows that trading more systems does not help as much in reducing the profit variance, because many popular trend-following systems are similar and have returns that are highly correlated. Finally, the question of why technical trading systems are profitable can be answered in terms of price variance.