Q: 1. What is the best way to investigate what the correlation between two trading systems is? By comparing both equity lines? Or by comparing the day by day trading results of both systems? Or by comparing the algorithms? Or maybe something else?
2. What do you think is the best way to investigate what the correlation between two instruments is (for example DJIA and SP500)? The historical quotes? Or by comparing the day by day price changes? Or maybe something else?
3. And finally, what do you think is the best choice: Diversification by using ONE trading system for TWO uncorrelated markets or using TWO uncorrelated trading systems for ONE market?
A: All your questions are based upon some assumption of what best means? And I have no idea what it means to you… only to me. The following comments should indicate why.
When I suggest that people use non-correlated trading systems, it really means that there is very little relationship between the concepts behind it. Thus, a trend following systems that looks for a well established pattern before it entered, should have very little correlation with a bottom picking trading system that looks for extreme down moves and then attempts to catch sharp 1-3 day reversals.
Now both of those systems could make money every week and would appear correlated, but I would say that they are not because the concept you are trading is so different. That’s really my definition of non-correlated systems and my criterion. But it might be quite different from yours. As far as equity curves are concerned, I’d like all my systems to be highly correlated in that they ALL have a LARGE PROFIT every month.
Why would you want to measure the correlation between the S*P 500 and the DOW. The S*P 500 contains generally contains the DOW, does it not?
Again, for question 3, I have no idea what you mean by best. What are you trying to accomplish through diversification? That might define what’s best. And why would you want to diversify when some of the best investors (like Buffett) say that diversification is a substitute for ignorance.