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DWC DARWIN- Mean Reversion, Stable Volatility

Advantages of Trading $DWC vs. Other Assets

This post describes some of the advantages of trading $DWC over other listed assets on the DARWIN Exchange.

Click here to watch the Webinar Recording.

The underlying fundamentals of DARWIN $DWC give rise to historically consistent behaviours in the asset that benefit both active and passive traders.

Compared to any other DARWIN on the Exchange (where only the DARWIN Provider’s decisions affect the asset’s movements), it considers a large number of community participants’ behaviours in its decision-making.

This affords its investment attributes and returns profile, a higher level of statistical significance than other DARWINS, and presents advantages for both active and passive trading.

We go on to describe these benefits in terms of:

  1. Return
  2. Risk and,
  3. Suitability as a Trading Instrument.

1) Return: Range-Bound Returns / Cycles

$DWC’s returns visibly demonstrate a fair degree of mean reversion, fluctuating in a stable range compared to other assets on the Exchange.

This range-bound behaviour presents itself on all time-frames in the $DWC, enabling short, medium and long-term traders to trade the asset.

For a quantitative perspective on this, you may find the following blog post useful, where we have conducted mean reversion tests using the $DWC dataset on six different timeframes:

[Darwinex Blog] Mean Reversion Tests on DARWIN $DWC

 

Active traders in particular can benefit from this tendency by e.g. being able to trade the $DWC standalone if they wish, designing strategies around the asset as it approaches its historical peaks (resistances) and troughs (supports) on any time-frame of their choice.

DWC Range-Bound Returns Cycles

DWC Range-Bound Returns Cycles (1-Year)

 

As its primary function is trading the opposite of asymmetric community exposure – behaviour which in itself is mean reverting by definition – $DWC demonstrating cyclical returns in this manner makes sense, further strengthening the case for active range-trading strategies leveraging this tendency.

This benefit is not limited to just active traders, as passive traders too can leverage this behaviour to time $DWC portfolio allocations for better value.

 

For more on this, you may find this blog post and the following webinar recordings helpful:

  1. [Webinar Recording] $DWC – Real Time Sentiment Index & Security
  2. [Webinar Recording] Effects of Market Volatility on Trader Performance
  3. [Darwinex Blog] Hedging DARWIN Portfolio Risk with $DWC

 


2) Risk: Stable Volatility Profile

$DWC trades a large number of currency pairs simultaneously.  The combined portfolio of currency pairs results in individual assets effectively cancelling out each other’s excess volatility, leading to stable movements overall in the $DWC.

DWC - Assets & Timeframes Summary

DWC – Assets & Timeframes Summary

Stable volatility coupled with mean reverting returns cycles, therefore makes $DWC a strong candidate for range-trading.


3) Suitability as a Trading Instrument

Active traders in the Darwinex Community frequently engage in trading price ranges and short-term retracements on currency pairs.

Retracement Trading Example

Range/Retracement Trading – Negatively Impacted by Deep Market Movements

 

Deep market movements in currency pairs can adversely affect such strategies, making range and retracement trading opportunities incredibly hard to exploit in live trading – especially for beginner traders.

With its stable volatility and mean reverting properties, $DWC presents traders (particularly those with mechanical trading strategies) with stable range and retracement trading opportunities, making it a suitable alternative to volatile currency pairs.

 

DWC - Normalized (With Range Boundaries)

DWC – Normalized (With Range Boundaries)


Webinar Recording: Advantages of Trading $DWC vs. Other Assets

Do you have what it takes? – Join the Darwinex Trader Movement!

Darwinex - The Open Trader Exchange

Darwinex – The Open Trader Exchange

Loss Aversion (Behavioural Finance)

Hedging DARWIN Portfolio Risk with $DWC

In this blog post, we’ll discuss how DARWIN Investors can diversify away some of the excess risk posed to their portfolios by Loss Aversion, a common and well-researched phenomenon in behavioural finance.

In particular, we’ll discuss why it makes sense to include DARWIN $DWC in a portfolio that’s partially or entirely composed of loss averse DARWINS.


But first,

  1. A quick recap on what Loss Aversion is,
  2. Why even the most perfectly diversified portfolio of DARWINs can be susceptible to unforeseen shocks due to loss averse behaviour,
  3. What DARWIN Investors can do to hedge this risk.

Loss Aversion (Illustration)

Loss Aversion (Illustration)

Loss Aversion:

Simply put, traders are said to be loss averse when they hold on to losing trades for extended periods of time, but take quick profits on winning trades.

It yields two main outcomes:

  1. Returns growth looks fairly steady during periods of profitability, small profits smoothing the curve.
  2. Major drawdowns however, are disproportionately larger – sometimes leading to prior profits being wiped out by the closure of large losing trades that were being held on to for a long period of time.

 

Granted, a diversified portfolio of reasonably uncorrelated DARWINs has its advantages in terms of minimizing overall portfolio risk.

However, if it contains DARWINs with poor scores for the Loss Aversion attribute (La), it may still be susceptible to shocks during:

  1. Periods of market turbulence,
  2. Deep unforeseen movements,
  3. Unusually volatile news releases,
  4. Black swan events, etc.

.. where diversification benefit temporarily breaks down, owing in part to losing trade closures that distort the portfolio’s original risk profile.


What can DARWIN Investors do to protect themselves?

In one of our recent posts – $DWC – A Real Time Sentiment Index & Security – we highlighted the fact that DARWIN $DWC replicates the opposite of the Darwinex trader collective’s behaviour.

GBP Flash Crash (October, 2016)

GBP Flash Crash (October, 2016)

It typically rises during times when loss averse traders experience undiversifiable risk.

For example, $DWC profited from the GBP Flash Crash.

Undiversifiable risk also frequently presents itself when loss aversion eventually leads traders towards margin calls, causing sudden, unexpected volatility in the overlying DARWINs.

 

In such situations, portfolios that contain DARWIN $DWC can benefit from DWC hedging away a significant proportion (depending on position management of course) of undiversifiable risk experienced by investors.


When does it make sense to include $DWC in a portfolio?

  1. Investors can include $DWC in their portfolios to hedge against DARWINs with a Loss Aversion (La) score < 4.0 and Capacity (Cp) score > 5.0.
  2. Capacity (Cp) > 5.0 describes DARWINs that primarily trade long term movements. If such DARWINs also have a Loss Aversion (La) score < 4.0, the investor’s portfolio is likely exposed to undiversifiable risk at some point in the future.

    Low Loss Aversion Score

    Low Loss Aversion Score

  3. Check the Correlation of low La DARWINS against the $DWC – If they are negatively correlated, it becomes more likely that $DWC will offset excess risk should the loss averse DARWIN encounter  undiversifiable risk.

    Check Correlation of Loss Averse DARWIN Against DWC

    Check Correlation of Loss Averse DARWIN Against DWC


What composition of assets could well diversified DARWIN portfolios (hedged against loss aversion) contain?

Example Portfolio #1:

  1. 50% Short Term DARWINs (Capacity < 5.0)
  2. 25% Long Term DARWINs (Capacity >= 5.0)
  3. 25% allocation to $DWC as a hedge against loss aversion / undiversifiable risk.

Example Portfolio #2:

  1. 40% Short Term DARWINs (Capacity < 5.0)
  2. 30% Long Term DARWINs (Capacity >= 5.0)
  3. 30% allocation to $DWC as a hedge against loss aversion / undiversifiable risk.

Note: Investors should of course exercise their own discretion in selecting portfolio allocations. The examples above illustrate what such allocations could look like, accounting for multiple timing horizons whilst hedged to a reasonable degree against loss aversion.


Webinar Recording: Effects of Market Volatility on Trader Performance

Do you have what it takes? – Join the Darwinex Trader Movement!

Darwinex - The Open Trader Exchange

Darwinex – The Open Trader Exchange