Trying to smooth equity with multiple system filters is really bad idea

In the past, I used to be like most of the ATS traders and developers: I put an enormous amount of energy into each single strategy and had a vision of getting a perfect, smooth, stable equity. Yes, sometimes perfectionism is a good thing. Many times, however, it is a curse.

In the case of ATS development, it often does more harm than good. The more you try to make your strategy (and especially equity) perfect by adding more and more filters, the more you curvefit and overfit your strategy to the past data. The future live performance is, in most cases, fatal.

I could have probably saved plenty of money if I had known that with a basic portfolio of simple strategies (with minimum system filters) you could smooth your equity perfectly – and at the same time keep your strategies really simple, with the minimal amount of system filters. It was just a few years ago when I realized about that and started spending much more time on perfecting the portfolio instead of my systems.

Now, let me give you some examples that show how a simple portfolio can really smooth your results and stability of the equity and returns – hopefully, it will help you to see where the real effort needs to be placed on.

Let’s start with the simplest example:  a mini-diversification, just across different markets within one futures class – in this case it’s going to be the indexes futures class.

I took a small variation of my system called BOSS ATS (you can download this system for free) and simply put together the version for emini S&P market, emini Dow Jones market, and emini NASDAQ market. So in this case, it’s simply one system diversified over 3 different markets within the same futures class - and surely with a pretty high correlation between the 3 systems.

The result looks like this:

Probably, the most important metric here is the Net Profit / DD ratio, which we want to have as high as possible. We simply want to have much higher profits than drawdowns. In the case of this min-portfolio, the ratio is 9.69. Not bad, but not great either. We can definitely do better, by also smoothing the equity.

Now, let’s try a different example.  We’re still going to stick to 3 trading systems, but now, we’ll diversify a little bit further. We’ll keep only the emini S&P (ES) version of BOSS ATS, and combine it with a completely different swing system designed by emini Russell (TF) market, plus with one system for Soybeans (S). So now there will be a diversification across 2 market futures classes (indexes – ES and TF, plus grains – S). The whole three systems are low correlated among each other. What happens now? Just have a look:

Not only is the equity much smoother all of sudden, without the need to touch the underlying systems, but most importantly, we have also increased the Net Profit / DD ratio significantly, which jumped to a very nice 18.46. This is way better! So, as you can see, you can just do a great job by making a very small portfolio, and only 3 systems can bring you a real improvement, without the risk of overfitting or curvefitting when trying to “fix” your systems by adding multiple filters. Finally, what happens when we combine much more systems together? Can it bring even better progress?

In the last example, I put a bunch of strategies together, both high correlated (like all the versions of BOSS) and really low correlated ones. To be more specific, I put together 7 systems over 3 futures classes (Indexes, Bonds, and Grains). So far, this has been the biggest jump you could have seen:

The equity looks really smooth now (and surely it can still get much better), without touching the underlying systems or increasing the danger of overfitting. Even better, the Net Profit / DD ratio is at 29.58, which is an absolutely excellent number, hardly achievable with a single ATS strategy that would be simple at the same time and contain minimum filters.

So, this is my lesson for today: Stop thinking in terms of a simple system and start thinking about the bigger picture. Don’t repeat my mistakes.

(P.S. I took this picture several years ago in Angkor Wat / Cambodia. Angkor Wat is the biggest temple complex in the world and its scale is unbelievable. It reminds me that the sky is really the only limit, so, you can reach the summit – without setting any limits in your mind. As for this article, you should think especially big when it comes to portfolios. You can just scale it to the size of Angkor Wat. The sky is the limit and there is no reason why you couldn’t have hundreds of ATS in your portfolio!)

Author: Tom Nesnidal