THIS CHAPTER IS FOR ASSET ALLOCATING INVESTORS WHO MOSTLY don’t believe that assets’ prices can be forecasted, and use the ‘no-rule’ trading rule within a systematic framework to allocate trading capital between different assets.
You have quite a large account size, so in theory you could have an allocation to a large number of ETFs without having any difficulties with the minimum size problem I discussed in chapter twelve, ‘Speed and Size’ (page 200). However to make this example more tractable I am going to limit your portfolio to just ten instruments.
There are several other considerations when choosing ETFs and you should consult one of the books mentioned in appendix A to understand these. Finally, this selection does not constitute an endorsement for these specific products, and the information I’ve used to choose them will almost certainly change in the future
Because you’re going to use the ‘no-rule’ trading rule I introduced in chapter seven your forecast will always be +10. To scale positions you’ll need to estimate the standard deviation of instrument returns, the price volatility. As suggested in chapter ten, ‘Position Sizing’, you’ll estimate this with a moving average of daily returns. However you need to think about what look-back to use for the moving average.
Working out the achievable volatility target given limited leverage is a twostep process. The first step involves making an initial guess as to what the target should be. You then work out if that is higher or lower than you could achieve given the amount of leverage you have available. The initial guess is then adjusted.
Notice how most of the equity selling is caused by increases in price volatility, rather than the changes to instrument weights. That draws this example to an end as you’ve now seen most of the significant trading action, although it’s tempting to continue and let the bond overweight come good.