Portfolio Optimization | Lesson 6

What if I told you that there is a nearly certain way to improve your returns and dramatically mitigate your losses? What if it didn’t require you to pick better stocks or coins? What if it meant that you’d also have more free time? Would you do it?

Paradoxically, most people won’t.

The reason is simple, the strategy for accomplishing all these aims is to contain your execution risk. That’s the unquantifiable risk you take on from being unable to execute on your trades well. Let me give you a memorable story.

This was back in 2016 and I was trading volatility derivatives. I had a good system for doing this. I was also cocky enough to go for a month-long environmental research retreat just South of the Grand Canyon. While I was out in the desert I got a fleeting signal on my phone that I needed to exit my position. It was a winner but market conditions had changed.

Because I had terrible cell reception, I simply couldn’t execute before we returned to civilization, and that meant waiting until the market open of the next day. So, I got up early to trade and sold what would have been a small win (about 5%) for a loss of about 8%.

The algorithmic strategy I had was accurate, but it didn’t match my lifestyle. Conversely, you could say that I was unwilling to change my lifestyle to match it. There would have been three obvious solutions for me, knowing that this strategy needed possible daily intervention:

1. Not hold any trades while I was going to be out of range,
2. Write a bot trader for my strategy (this proved risky in its own way, incidentally),
3. Hire other team members to help me execute.

These are all “dumb” solutions because they don’t require investing intelligence. They do require self-awareness.

For paid subscribers, the AOTB team tries to remain cognizant of these, so that the strategies used don’t require you to stare at your screen all day long. But you need to know how to match your time investments with the kind of strategy that you want to use. That’s the purpose of this lesson and everyone (I think) will benefit from it.

Let’s walk through each of the strategies offered here at AOTB as a case study. This way you can learn to think about how you can match your own lifestyle to the strategies that fit.

Three Week Time Scale

In the stock report, we cover four different strategies:

1. The Bubble Portfolio
2. The Leveraged Trader
3. The Tech Trader
4. The Triple Momentum Trader

Only the Triple Momentum Trader is at a 3-week time scale. All the others require at least weekly check-ins. Here is how it’s performed since 1999 (it’s the red line).

Present market conditions (you can imagine) aren’t great for a momentum algorithm, but it does quite well in up markets. It uses no macroeconomic data at all. It only trades on price momentum, which makes it an interesting play.

For the Triple Momentum portfolio, you simply buy 30 stocks and then check back in three weeks and make any changes necessary. Yes, it does perform better with 20 stocks, but I worry that using that smaller selection set makes its returns less robust (= better backtests but worse actual performance).

One Week Time Scale

I still like to think of these portfolios as what you should check daily, but it’s possible to position yourself to check them weekly. Portfolios at this time scale include:

1. The Tech Trader
2. Yield Farming

Here’s an example from the Yield Farming report. Note, we’re still updating it for readability, so I’ll explain a few points. The 50% numbers under the % Held column are for the BTC position on its own and the ETH position on its own (100% for BTC, 100% for ETH). “W. Return” means weighted return.

There aren’t official rating agencies, so any of those risk colors are just a starting point for your own due diligence.

I still check these daily, but as a yield farming strategy, you generally don’t have to do anything. The yields might go down, but then you’d just have to move them to a new pool. Which? Well, this is a weekly report and the AOTB team pulls data from all major blockchains, all major decentralized exchanges on those, and all top coins. We don’t do everything, but we get the overwhelming majority of opportunities.

You’ll notice that there are four stable coin positions that aren’t red (which is there for comparison purposes). The two yellows are flagged because they use USDT (which appears to be safer now after its most recent audit, but still). The idea is that you’d spread out your yield farming position on stable coins into four pools. The reason the position is spread out that way is simple: you need to mitigate protocol risk. So, it makes sense to have your money on a few different protocols.

But mitigating protocol risk increases execution risk. That’s the trade-off.

You’re not a hedge fund, which has a team of people who could easily watch 20 pools to keep protocol risk low while not increasing execution risk. 

So, pick what you can easily monitor. Also, if you don’t have too much money, then fewer pools might make more sense just to keep transaction costs down (and maybe avoiding ETH in favor of AVAX or SOL would help).

Daily Check Portfolios

We don’t have any portfolios that should require daily activity. But the main portfolios that the AOTB team offers require daily checking. These are our flagships.

1. AOTB Dynamic Portfolio
2. AOTB Bubble Portfolio

Notably, the Leveraged Trader is also a daily check, and it moves into position with a Green 5 rating and sells out with anything less.

For the Bubble Portfolio and Dynamic Portfolio, we have daily tickers. They look like this.

Basically, if you have something that’s green and it turns red, then the algorithm is signaling that it’s selling. Typically, you will have long stretches where you do absolutely nothing and then there will be a lot of excitement.

Honestly, if you were going to take a 2-week vacation and have sketchy cell phone reception, then it might make sense to sell out of your position for these until you could come back to monitor daily. 

Concluding Thoughts

So, that’s your primer on execution risk. It’s one that people often don’t consider, but which makes an enormous impact on your portfolio. In addition to mitigating your risks by diversifying your strategies, this is likely the most important risk to keep in mind.

It won’t improve your theoretical performance, but it will dramatically improve your actual performance if you can match your lifestyle with a trading strategy that works.

This week I wrote a number of pieces that are related to this post, so you might want to have a look if you’ve missed them.

That’s it for this week. Remember to join us on Discord if you haven’t already.

Happy Trading!!

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