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Measure Correlation Portfolio Diversification Trading Strategy

Research Study of Trading Timeframe Correlation

Timeframe correlation probably isn’t the first thing that comes to mind when thinking of correlation.

Trading uncorrelated assets will often be your first port of call. This is fine. On a small portfolio of passive strategies trading uncorrelated assets is most likely all that is needed.

But when you start to involve more active strategies trading multiple timeframes can add some excellent benefits. Trading uncorrelated assets is only ONE way to diversify a dynamic portfolio.

Timeframe correlation is something to not only be aware of but actively control.

Remember that a high correlation between assets can lead to increased risk. Timeframe correlation is no different, and this is what we’ll be diving into this time.

Should you trade every timeframe?

I wonder what we could do to provide an excellent visualisation of the timeframe correlation? How would we go about doing that? How about a heatmap?

We used a heatmap to illustrate the correlation between 40 different traceable assets on the Darwinex platform in a previous video. Let’s do the same thing for timeframe correlation. Let’s create a heatmap to give us a nice high-level overview of the situation.

One thing to consider with timeframe correlation is how you calculate the values. We need to adjust the way we get to the (R²) figure.

Previously, we first got each asset’s delta then used the delta to get the (R²) figure. We can’t do that with timeframes. Instead, We use the delta of returns of each strategy across a set period.

Quantify the timeframe correlation, don’t just guess it.

When you start looking into timeframe correlation, it’s a good idea to set parameters you feel comfortable with. You could have thresholds for low, medium and high. Then only consider using timeframes that fall into the low category.

So you’ll need to test this out yourself. You also may find that the same strategy on different assets provides different correlation across various timeframes.

It is always a good idea to perform these tasks on your own strategies and data. Each trader will have different levels they’re willing to accept.

You can follow the principles in ALL our videos and blogs and apply these to your own trading. That’s what it’s all about. Using the tools at your disposal and adapting them to suit how you trade, if needed.

@darwinexchange We love to talk shop. Get in touch to let us know how you’ve adapted any of the insight on our social channels. 

We love striking up a conversation with like-minded traders.

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.

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.