Aug. 22, 2019

A recent post made in a Quantopian forum.  (Sorry for the Quantopian links, the community website has shut down)

The trading strategy described in my article: Reengineering For More was designed to be controllable. We could be more aggressive by adding more pressure to its controlling functions, or slow it down at will if we considered it too much or felt it was going to fast. It is part of the advantage of having controllable portfolio level functions rather than having adaptive or fixed trading parameters. It remains a compromise between individual preferences and maximizing long-term objectives.

To see more on how this trading strategy evolved (its development was chronicled live) see my posts in the following thread:  where, step by step, this strategy was modified and enhanced from underperforming its own Buy & Hold scenario to the point of making it an awesome long-term performer. There is no magic trick in there, but a lot of math was applied in its reengineering.

When we look at the trading problem with a long-term perspective, we start to see things that are entirely related to how our trading strategies are structured and how they will behave over time.

It was shown in the last post that to double overall portfolio performance only required adding peanuts, alpha-wise, to a strategy on the condition we were ready to give it time. It is a compounding game with the end-game formula: Cap. ∙ (1 + r)^t. Therefore, all the emphasis should be on r, t, and the initial capital.

However, this basic scenario can be enhanced by adding some alpha (here given as g since it can be self-engineered): Cap. ∙ (1 + r + g)^t.

As example, the 30-year scenario starting from a 10% CAGR base only needed g = 2.57% in added return to double its outcome. The same base scenario would need g = 4.10% to triple it over those same 30 years. Only 1.53% more alpha would enable one to triple the overall outcome compared to just doubling it.

The following chart shows the value of g needed given the number of years required to generate twice its outcome without it.

(click to enlarge)

Technically, because we are giving it time, it becomes like adding peanuts to the trading strategy. And from it, we could greatly improve performance. The chart shows that if you spread the task over a longer trading interval, it becomes easier and easier to achieve.

In numbers, starting with the usual \$10,000,000 cap. in Quantopian scenarios with a 10% CAGR as base, the end value would be \$174,494,023 after 30 years. Adding g = 2.57% would raise the total to \$348,988,045, while using g = 4.10%, it would produce as outcome \$523,482,068. Money-wise, this is not peanuts anymore!

You could take the above scenario and multiply it by 10. Simply add a zero to the initial capital and the outcome will be in billions, r and g would remain the same. This shows how valuable the added g can be to a trading portfolio.

You prefer to scale it way down by a factor of 1,000, it would still work, g, and r would remain the same, but then, be prepared to drop the last three digits and literally play with peanuts and for peanuts, as if throwing away its tremendous potential due only to lack of capital.

What the governing portfolio strategy equation presented in a prior post said is that we are not restricted to use only one bag of peanuts, we could throw in several of them in at a time to make it more interesting, giving: Cap. ∙ (1 + r + g1 + g2 + g3 + g4)^t.

A little nudge from routine #1 when and where applicable, another from routine #2 for its supportive presence, a little push here and there for the other enhancers, amplifiers and dampers you put in the trading strategy. All those bits and pieces have for purpose to gradually elevate overall portfolio performance over the long term where it counts.

Yet, their individual contributions might be barely visible over the short-term. Their power resides in having been continuously applied in a compounding environment for a long time. A little peanuts here and a little more there, it all adds up. All those small profits we feed our trading strategy will be compounding and compounding enabling our strategy to trade more and thereby profit even more.