Building high performing portfolios with The Machine is an easy task once you have the proper framework in place before building a portfolio. One of the keys to building a high-performing portfolio that all users need to understand is the concept of balance.
Many users are most likely familiar with the term balance as used throughout the financial services industry. When most hear the word balance, it usually refers to balancing the over portfolio amongst various asset classes such as stocks, bonds and cash. When building a portfolio with The Machine, users are taught to build a balanced portfolio of diversified strategies from 6 core strategy groups.
So, what does it mean to build a portfolio of diversified strategies? It means to include strategies from each of the 6 strategy groups in order to achieve balance. Traders would like to include strategies that buy the market as well as strategies that sell short the market. This is known as Directional Diversification. Asset Type Diversification is next, and users should incorporate a mix of sock strategies as well as ETF strategies. Finally, users should utilize Time Horizon Diversification, by implementing strategies that look to hold trades for different periods of time.
By adding these strategies together, you are getting a more balanced, more diversified, stronger portfolio. This is what allows you to potentially grow your wealth in any type of market environment.
This series is going to show traders the reasons as to why each of the strategy groups should be incorporated together. Let’s start with Direction Diversification and the reason as to how this helps the overall portfolio.
Ideally as users build a portfolio, both long as well as short strategies should be incorporated into the portfolio.
So, why is this important? This is important for a number of reasons. The most obvious is that the portfolio should be positioned to take advantage of when markets move both up and down. By adding short strategies the portfolio will be better positioned to potentially profit in bear market years. Also by adding short strategies to a portfolio generally it will increase the overall CAGR (Compounded Annual Growth Rate) of that portfolio and help to achieve those long-term consistent results that you need in order to grow your wealth. Lastly, statistics have shown that by adding short strategies to a portfolio the overall volatility (Standard Deviation) as well as the drawdowns of the portfolio can be lower.
Let’s now look at the statistics of two basic portfolios. These portfolios were built using stock and ETF strategies, and show the importance of creating them utilizing both long and short and ultimately making them better. The numbers tell users all that they need to know.
By incorporating both long and short strategies into this portfolio, there was an increase in the CAGR and a significant increase in the Sharpe Ratio as well. One of the most eye-opening changes is in the volatility or Standard Deviation as well as the drawdowns. The drawdowns were cut in almost half!
The goal is to build the best balanced portfolio of strategies that you can, and as we can see, incorporating strategies on the long side as well as strategies on the short side is a great starting point for building a balanced portfolio.
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