Introducing the Trade Risk Index
Starting fresh in 2022 we are going to start reporting the performance of our trading systems under the Trade Risk Index.
What is the Trade Risk Index?
The Trade Risk Index represents the aggregate performance of all publicly run trading systems on the Trade Risk. At the time of writing this, we currently have two distinct fully rules-based trading systems: Merlin and Lamorak.
Both of these trading systems were built with the same goals in mind:
- Beat buy and hold portfolios
- Do it with much smaller drawdowns
- Spend less than 10 minutes per day trading
Both systems achieve these three goals, but the way they go about it is very different from one another. That’s because the underlying trade logic, hold times, and rules for Merlin and Lamorak are unique.
How is the Trade Risk Index constructed?
The goal is to evenly allocate 50/50 across both systems.
That means a $100,000 portfolio would have $50,000 allocated to Merlin and $50,000 to Lamorak. Of course, once live trading starts, the portfolio values ebb and flow with one another and occasionally one system may start to outperform more significantly causing an imbalance in allocations.
Rather than get into a recursive loop of constant rebalancing every day, we put rebalance bands around the overall portfolio (index) and rebalance only when one system starts to have a 10% or greater allocation versus the other.
In these situations, we sell positions and move cash from the larger trading account to the smaller account, keeping in tact all of the exposure levels and allocations within each system.
How is performance reported?
We use a third-party auditing service called PortfolioAnalyst that monitors our live Interactive Brokers Pro trading accounts and generates all of the monthly and annual performance numbers and metrics you see reported each and every month.
Why create an index? Why trade two systems?
Like we mentioned earlier, both trading systems have different underlying logic. They buy and sell at different points in time and carry different exposures depending on the market environment. In fact, more often than not you can find one trading buying stocks while the other is selling them short!
What this does is create diversification among a single overall portfolio. Take this historic return table as an example:
| Month | Merlin | Lamorak | 50/50 Blend |
| November 2016 | +9.12% | -3.75% | +2.68% |
| March 2020 | -7.38% | +12.48% | +2.55% |
| September 2020 | -1.32% | +7.99% | +3.33% |
Notice in each of these months, we saw one trading system perform exceptionally well while the other trading system wasn’t so strong. Of course, if you were all in on the strong system, you were very happy, but the point is, you will never know which is going to be strong ahead of time, so the optimal strategy is to allocate to both.
By running a portfolio containing both trading strategies, maximum drawdowns are reduced, more months end with positive returns, and sharpe ratios are higher.
The Trade Risk Index
We strongly believe in combining unique trading systems together in order to be most effective at reaching our goals of beating buy and hold portfolio returns while maintaining smaller drawdowns.
The Trade Risk Index helps us showcase in a simplified fashion, how the collection of our systems have performed. For those of you who want to dig deeper into the numbers, we’ll always show you which system contributed to the monthly gains/losses on our performance page and monthly blog updates.
If you’d like to test drive our trading systems, check out our $1 trial offer to get started.
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