TRADETHINK ARTICLES

A Diversified Trading Approach

September 14, 2007

By Chris Morse

A successful trader will at times follow up to 30 markets or more on up to three different time frames. Why follow this many markets and time frames? A given market may only trend 30 percent of the time. This means that most of the time a market is not trending and is choppy. To compensate for the lack of time a market is in a trend a good trader will follow multiple markets which will give the trader much more of a chance of finding where the trends are. Different time frames allow the trader to benefit from the variation of how a trend will setup and follow through each time. Sometimes a trade will go up very fast and fall back even faster (good for short-term). Other times a nice trade will look like climbing a mountain on the way up and back down (good for long-term).

Markets

It is important for a trading system to be able to follow multiple markets since an individual market may present trading opportunities at any given time.  If a given market is only trending a third of the time or less it makes good sense to follow multiple markets.

There are many market sectors in the commodities markets. There are even more markets within each market sector. For instance, market sectors may include the Indices, Financials, Currencies, Fuels, Metals, Meats, Grains and Softs.

Within just the Grains sector there are three main markets; Corn, Wheat and Soybeans. Further in the Grains you have Oats and Rice. You even have different variations on certain grains or complexes. Soybeans have Soybeans, Soybean Meal and Soybean Oil. Wheat trades Winter Wheat and Spring Wheat.

If one was to just be following Corn right now and not Wheat at the same time they could have missed out on a great trend that is currently going on in Wheat right now.

Take a look at the chart below to see how the trading system is tracking Wheat.



Look at the most recent trade signals for Wheat. The blue arrow pointing up is the entry signal. The light blue/cyan arrow pointing down is the systems exit. Clearly Wheat has been trending quite well.

Now let us look at a Corn chart.

 

Look at the most recent trade signals for Corn. The red arrow pointing down is the short entry signal. The light blue/cyan arrow pointing up is the systems exit. In this case the Corn is very choppy.

As you can see the Wheat trade is trending up while the Corn trade is trending down and choppy. If you were following Wheat you would be a winner. Had you just been following Corn you might be a net loser. Had you been following Wheat and Corn at the same time you would be in a good position to be a net winner. This is why it is very important to follow multiple markets. The more markets you can follow the more diversification you have.

Multiple Sectors

For even more diversification you will want the ability to follow several market sectors. There are eight market sectors in the commodities markets; Grains, Currencies, Financials, Meats, Metals, Fuels, Softs and Indices.

Had you been following just the Grains this year you may be a profitable trader. If you were following the Grains in 2006 you may have lost money. On the other hand if you have been following the Metals this year and last then you should be profitable in the Metals. Had you been following the Metals and Grains simultaneously the past two years you should have been successful. As you apply more market sectors to your portfolio the possibility of catching the trending trades goes up exponentially.  This is where a good trading system comes in handy. This is by allowing you the ability to calculate trends across many market sectors.

Time Frames

Look at the picture below and see three popular trading strategies following an identical twenty market portfolio.


There were times when the short-term time frame performed best and there were times when the medium-term and long-term time frame did best in a given year. Most important is the “All Time Frames Combined” column. By combining and applying three different time frames to a portfolio you have a more consistent equity curve. As a great trader once said “The only free lunch on Wall St. is diversification”.

Trading System

It can be very difficult for a person to follow thirty or more markets every single day. A well diversified trend trader will typically use a trading system such as Trade Think to track the markets for them. A trading system can do numerous calculations on a multitude of markets in the blink of an eye. Best of all a trading system will work for you every day. The system will not get tired or sick. Maybe you want to play golf or spend time with your loved ones. This is where a good diversified trend following system will be your friend. A good trading system will be completely automated in generating its trading signals for you. A good system will work on a multitude of markets, market sectors and time frames. A good system takes the emotion out of trading.

Summary

What is the catch? This type of diversification comes with a pretty steep entry fee for some. It typically takes a minimum financial commitment of at least $30,000 to follow a single time frame on about 20 markets across seven market sectors. To follow a 20 market portfolio across three time frames it can involve a portfolio of a minimum of $100,000 or more.
I wish you the best of luck in diversifying your commodities portfolio.

About the Author

Chris Morse is the Developer of the TradeThink trading system. He has been involved in the development of trading strategies for nearly ten years. Mr. Morse developed a very robust system which is now in private use at one of the largest FCM's and has earned sizable returns for the last 3 years. Mr. Morse now focuses his time exclusively on developing and managing his systems.