#085: INTERVIEW: HOW TO BUILD A PORTFOLIO FOR STEADY TRADING INCOME

Today I am bringing you a very interesting interview with one of my brokers (who throughout the many years of being my personal broker has become my very good friend, too), Martin Lembák, who has a great deal of experience with portfolios and, thanks to this, has important observations and findings that can be very useful for all traders.

Martin, you have been for many years a part of a team of a brokerage company called Striker.com which focuses mainly on ATS (Automated Trading Strategies) trading. You are regularly analyzing trading systems and their performance but you are also preparing portfolios created from those systems for clients. Therefore, you have a lot of experience with portfolios. Right from the beginning, I would be curious to know - what is the best way to diversify in order to gain stable income? What are the basic rules?

Well, certainly not only ATS (also self-directed online trading on many platforms). But yes, systems are what Striker does from 1997 since the beginning of the expansion of ATS. Today, Striker also runs white labeling of systems from different developers from the whole world, traded in firms by other brokerage houses in the US and in other parts of the world. There is also a large number of clients who have their own systems and who are letting them be executed in a top-quality environment, literally only a few meters from Chicago's Exchange servers where Striker has its offices.

Yes, diversification is very important and the key requirement is that a portfolio consists of systems that historically don't correlate.

Therefore, it is good to have strategies across many different markets, timeframes, and with different logic-defining entries and exits.

Of course, I am talking about a good-quality ATS that functions not only on historical tests but also in out-of-sample ones and in real trading.

It is also important to remember that the correlation between gains can change and it is always good to define different phases of the market and examine if there are any periods when performance among different systems can be similar. And then get ready for such phases (even a well-diversified portfolio will experience drawdowns in the future).

As you know, I personally focus on breakout strategies. From your experience, how many of them should a trader develop in order to create a ‘perfect' portfolio?

In my opinion, it is mainly important to combine markets from different sectors such as indices and then, for example, commodities such as coffee, sugar, cocoa.

Then, for example, also grains, but here we need to be careful with daily limits on these futures contracts to not stay locked in the market in the wrong direction without the possibility to exit.

We can also consider metals such as gold, silver, copper; although at present such markets can be impacted by macroeconomic factors more than ever before. The movement is also similar to that of indices.

In regards to bond contracts, there is also a large correlation with indices, even though inverse in most of the times.

From my practice, I am pretty skeptical towards intraday trading of forex (FX) based on technical analysis or algorithmic trading. Forex is a largely fundamental market where there are strongly-represented large banks and funds.

There is a relatively good experience with futures on energies such as crude oil and natural gas or gasoline.

It depends on the size of the portfolio but it seems that 5-7 markets with the application of a given system should provide diversification within one method such as breakout.

From your experience: if the account is growing, is it better to add contracts (position sizing) or systems (as I call it 'system sizing')?

In the past, I have spent a lot of time on this topic and I can say I am an advocate of a classical approach of fixed dollar amount of equity when it comes to position sizing. It means to add another contract only if the original account doubles and in the situation of a larger drawdown to reduce one and so on.

Other position sizing methods such as optimal f, full Kelly, and others which are definitely much more aggressive and I am not a fan of them.

And I would suggest ‘system sizing’ - as you call it - as well. It is a good approach to keep diversifying among more markets all the time.

Do you think it is possible to create a quality portfolio for stable income only in one market sector only (e.g. indices) or is it better to use as many different markets as possible?

It is definitely possible to create a portfolio in one market sector. Anyway, I think for better smoothing of equity (plus keeping or even increasing income potential) it is good to try to also deploy different market sectors. Such other markets should have a price trajectory as different as possible from the "original" one.

What about diversification among different timeframes in the same market - does it also help?

I would rather diversify among different markets with different movements and use as many different logics of different ATSs as possible.

Students of my Breakout Masterclass often start with an account between 10,000 and 30,000 USD for which they build their own systems. How many systems/markets would you suggest for accounts of 10, 20, or 30,000 USD? And in general what market would you suggest for ATS with smaller accounts?

Yes, this can be built pretty easily.

As I mentioned earlier, optimally it is good to apply at least 5 systems in 5 different markets.

As an example, this is one of the portfolios we trade for one of our clients with a 20k account:

One swing ATS that trades 1 contract on indices (emini Russell),
1 ATS system on Kansas wheat,
1 ATS on soybean oil (grains markets),
1 ATS on cotton (softs markets),
and finally 1 ATS on Euro futures (currencies markets).

Here you can see an impact of the portfolio (backtests with commissions from the last 6 years (till May 2017)- designed solely for study and past results are not necessarily indicative of future ones):

Notice the Reward to Risk ratio of 20.88, which is a very good number, hardly achievable with a single strategy (and can get even higher with more low-correlated systems in the portfolio).

Thank you! And the last question. If traders want more trading tips from you, based on your experience with almost 1,000 trading strategies from many different traders, how can they get them?

The easiest way is to download my completely FREE Beginner Roadmap.

(Click on the picture to get Martin's Ultimate Roadmap).