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Correlation Portfolio Diversification

A Macro-Economic Study of Correlation between Tradeable Assets

It can be challenging to visualise the correlation between assets when you have a whole portfolio full of them. You can create a heatmap that shows all the assets in your portfolio and the correlation between them.

And in true Darwinex fashion, we’ve created a heatmap for 40 of the Darwinex platform assets. This heatmap gives us a high-level view of the correlation between this universe of tradeable assets at Darwinex.

It might look like some random NFT, but what this heatmap does is display the correlation between every asset in an easy to see manner. Using a heatmap in this way can help speed up asset selection when deciding on what to put in your portfolio.

Correlation is the enemy of Diversification.

It gives you a clear view of what combinations of assets are likely to provide good diversification benefit and which ones are likely to not. This extra clarity is essential because trading correlated assets can increase the risk on the portfolio.

What is Delta?

Delta is a mathematical term that simply means a change in value. In a previous post, we showed you how to calculate (r) and (R²), but we highlighted a flaw in this approach and showed you how to calculate (R²) using the Delta (the price change) instead, which is a much more robust way to calculate the correlation.

Using the heatmap, we can see the correlation between an FX major like GBPUSD and the FTSE index. Looking at the heatmap, we can quickly see that these have a correlation of 0.00036. This correlation would indicate that trading these two assets at the same time could provide us with diversification benefit.

Take a look at Martyn’s heap map. If you had to pick 2 FX pairs, a stock index and a commodity, what would you choose and why?

As always, answers on a postcard @darwinexchange

This post covers the correlation between assets. But there are three other techniques we’ve used previously. In the next episode, we take a look at the correlation between timeframes.

Brought to you by Darwinex: UK FCA Regulated Broker, Asset Manager & Trader Exchange where Traders can legally attract Investor Capital and charge Performance Fees.

Risk disclosure:
https://www.darwinex.com/legal/risk-disclaimer


Content Disclaimer: The contents of this video (and all other videos by the presenter) are for educational purposes only, and are not to be construed as financial and/or investment advice.

Benefits of Portfolio Diversification

Portfolio Diversification | Same Asset Class

It is possible to gain Portfolio Diversification benefits from within one asset class. The whole purpose of Portfolio Diversification is to try and build a robust portfolio of trading strategies; that perform well in a host of different economic environments.

Whilst you need to be selective of the assets you chose, the portfolio diversification benefits are clear.

Diversification is a tool that we can use to strengthen our portfolio. Being able to diversify across different asset classes, and within the same asset class, allows us to take a multi-pronged approach.

Care must be taken.

Although it is possible to diversify within an asset class, care must be taken because some assets within the same asset class are less correlated than others. For instance, in the commodities asset class, Natural Gas isn’t correlated to Coffee.

In the video below, we’ll go over another example using three uncorrelated forex pairs. Because they’re uncorrelated it means they provide a diversification benefit despite being in the same asset class.

It is important to note, due to the random aspect of the financial markets, two uncorrelated assets can exhibit correlated behaviour some of the time.

In this last post on Portfolio Diversification, we touched on some of the metrics you can use on the Darwinex platform to see how diversified and robust your portfolio is.

We’ll go over one of the investible attributes to further illustrate how useful these can be. The OsCs investible attribute provides a what-if scenario metric. It looks at the quality of the traders’ entries and exits and simulates results based on different entry and exits.

Darwinex provides 12 investible attributes that allow the trader to review different aspects of their trading strategies performance.

Along with various other metrics, these provide a powerful suite of tools to analyse the effectiveness of your edge. Using these the trader can judge entry/exit performance, scalability of the underlying strategy and diversification benefit to name a few.

What do you think the most important trading metric is to a trader?

Tag us on Twitter (@Darwinexchange) with your thoughts.

Brought to you by Darwinex: UK FCA Regulated Broker, Asset Manager & Trader Exchange where Traders can legally attract Investor Capital and charge Performance Fees.

Risk disclosure:
https://www.darwinex.com/legal/risk-disclaimer


Content Disclaimer: The contents of this video (and all other videos by the presenter) are for educational purposes only, and are not to be construed as financial and/or investment advice.