Do More Markets Mean More Trading Portfolio Diversification? The Lesson from Gold and Platinum

Does adding a new market automatically make a trading system portfolio more diversified?

Not necessarily.

Trading the S&P 500, Nasdaq, and DAX means using three different instruments. However, during certain market phases, major stock indexes may move in the same direction and react to the same events.

This does not mean that adding markets is pointless. Rather, it means that simply counting the number of instruments being traded is not enough to assess trading portfolio diversification. You also need to consider what drives those markets, which approaches the trading systems use, and, most importantly, how the strategies behave when combined.

Let’s imagine two precious metals strategies: a reversal strategy on gold and a trend-following strategy on platinum, operating on different timeframes.

Can they truly be considered diversified? As we will see throughout this article, answering this question requires several important considerations.

What Does It Mean to Diversify a Trading System Portfolio?

Diversification means avoiding a situation in which every component of a portfolio depends on the same market conditions to produce results. A portfolio concentrated in a single strategy, market, or type of market behavior may be particularly vulnerable when market conditions change.

For example, a trend-following approach may perform well when sufficiently large and persistent directional moves develop, but it may struggle during sideways phases characterized by frequent false breakouts.

A mean-reverting strategy looks for different conditions. It attempts to capitalize on price moves considered excessive and the subsequent return toward values closer to the average.

Combining strategies that react differently to the same conditions can therefore contribute to trading system portfolio diversification.

Diversification can be pursued across several dimensions:

• different markets and asset classes;
• different trading approaches;
• different timeframes;
• long and short trading;
• different entry times or periods;
• strategies that respond to different market conditions.

The important thing to remember is that none of these factors, considered individually, guarantees a well-diversified portfolio. The outcome depends on how the systems interact when used together.

Different Markets Can React to the Same Factors

One of the most common mistakes is confusing the number of instruments with the degree of diversification.

Consider a portfolio containing dozens of strategies on the S&P 500, Nasdaq, DAX, and Euro Stoxx 50.

These are different indexes, listed on different markets and tied to geographic regions that do not overlap perfectly. This can certainly provide some degree of diversification.

However, during a global shock, stock indexes often become more highly correlated. A sudden change in interest rate expectations, a financial crisis, or a geopolitical event can trigger similar moves across all these markets.

In such a situation, multiple trading systems could enter a drawdown at the same time.

It is therefore more accurate to say that diversification is not a fixed characteristic. It can change over time, especially during periods of heightened market turbulence.

Precisely when diversification is expected to provide the greatest protection, some historical correlations may increase and put a trading system portfolio under pressure.

Market Drivers Are a Useful Starting Point

When making an initial selection of markets, it can be helpful to identify the main factors that influence their prices. These may include:

• interest rate expectations;
• currency movements;
• economic growth;
• inflation;
• energy supply and demand;
• weather conditions;
• production and harvest cycles;
• industrial demand;
• investors’ overall risk appetite.

One important aspect of these “market drivers” is that their impact is not always as clear-cut as it might seem. The same instrument may be influenced by several drivers at once, and their relative importance may change over time.

Gold, for example, can react to real interest rates, movements in the US dollar, inflation expectations, and demand for safe-haven assets. Platinum belongs to the same general precious metals category, but it also has a significant industrial component. As a result, gold and platinum may move together during certain phases and behave differently during others.

Analyzing market drivers can therefore help identify potential concentrations, but it is not enough on its own to determine whether two trading systems are truly diversified.

Gold and Platinum: Same Sector, Different Strategies

In a previous Unger Academy article, we presented two strategies developed on gold and platinum, respectively.

The first trades gold futures using 15-minute bars and a reversal approach. The strategy waits for a false breakout of the previous session’s high or low before entering in the opposite direction of the initial move.

The second was developed on platinum futures. It uses 60-minute bars and a trend-following approach based on the breakout of a price channel.

We therefore have:

• two different markets;
• different timeframes;
• one reversal strategy;
• one trend-following strategy;
• different contract specifications.

These factors can contribute to trading portfolio diversification. However, we cannot automatically conclude that the two systems are completely independent simply because they use different approaches. Likewise, it would be incorrect to claim that they offer no diversification simply because they both trade precious metals.

To understand their contribution to the portfolio, we need to analyze their combined results.

Market Drivers and a System’s Trading Logic Are Not the Same Thing

It is important to distinguish between what moves a market and what a trading system attempts to capitalize on.

An interest rate increase, a supply shock, or a change in industrial demand can be considered a market driver.

Trend following, mean reversion, breakouts, and seasonality are approaches used by strategies to identify specific trading conditions.

These two dimensions can interact, but they are not the same. Two systems built on the same market may provide some degree of diversification if they use different approaches and experience losing periods at different times.

Conversely, two strategies applied to seemingly unrelated markets may generate losses at the same time if they react similarly to a particular market condition.

For this reason, market diversification and trading strategy diversification should be evaluated together.

How to Measure Correlation Between Trading Systems

After an initial qualitative assessment, it is time to look at the data. Correlation between trading systems shows the extent to which the results of two strategies tend to move in the same direction.

A high correlation indicates that the systems often produce similar changes in performance. A lower correlation suggests greater independence between their results.

However, this metric should be interpreted carefully. A correlation calculated over an entire backtest may conceal what happens during the most difficult periods. Two strategies may appear weakly correlated under normal conditions but begin losing at the same time during a market shock.

In addition to overall correlation, it is therefore useful to examine:

• overlapping drawdown periods;
• the portfolio’s worst days or weeks;
• performance across different market regimes;
• simultaneous exposure in the same direction;
• each strategy’s contribution to overall risk;
• potential increases in trading system correlation during periods of stress.

The goal is not to find systems that never lose at the same time, as this would be an unrealistic expectation.

The goal is to prevent an excessive portion of the trading system portfolio from depending on the same conditions and to avoid having several strategies experience their largest losses during the same periods.

System Weightings Also Affect Trading Portfolio Diversification

Adding many markets to a portfolio is not particularly useful if most of the risk remains concentrated in a single asset class.

Suppose we have ten trading systems but allocate a much larger share of capital to stock index strategies than to all the other components.

On paper, the portfolio contains numerous strategies. From a risk perspective, however, it may still depend primarily on the performance of equity markets.

For this reason, we need to consider not only which systems are included, but also:

• the capital allocated to each system;
• the volatility of the different markets;
• position sizes;
• contract values;
• the maximum expected loss;
• the portfolio’s simultaneous exposure.

Two strategies may have a low correlation, but one of them could have a much greater impact on overall risk than the other. Simply counting the number of systems does not reveal this difference.

Diversification Does Not Mean Adding Markets at Any Cost

A new market may be valuable when it introduces characteristics that are missing from the existing portfolio.

Before adding it, we can ask several questions:

• Does it belong to a sector that is already heavily represented?
• Which factors have the greatest influence on its price?
• Does the strategy use an approach that is already present in the portfolio?
• Do its drawdowns overlap with those of the other systems?
• How does adding it change the portfolio’s overall risk?
• Does it improve the relationship between returns and drawdown?
• Is the market sufficiently liquid for the available capital and intended trading approach?

The decision should not be based solely on the new system’s equity curve.

A strategy may produce excellent results on its own and still make the portfolio less balanced if it adds to an exposure that is already overrepresented.

Conversely, a system with less impressive standalone results may make a valuable contribution if it tends to perform well when the other strategies are going through unfavorable periods.

A Multi-Market Portfolio and a Multi-Market System Are Two Different Things

Portfolio diversification should not be confused with the ability to apply a single trading system to several instruments.

As we explained in our analysis of trading systems that can be used across multiple markets, some approaches can be adapted to different instruments, while others depend on the specific characteristics of the market for which they were developed.

This is a decision related to the development and robustness of an individual system.

Trading portfolio diversification, on the other hand, concerns how multiple strategies are selected, sized, and combined.

A multi-market system can still create concentrated exposure if all the instruments it trades react to the same factors. At the same time, different systems developed separately can form a balanced portfolio if their risks do not overlap excessively.

Market Diversification Must Be Verified, Not Simply Claimed

Adding different markets can improve trading portfolio diversification, but the number of tickers alone is not a sufficient measure.

The analysis should cover at least three levels:

1. The markets, asset classes, and main risk factors.
2. The approaches and conditions exploited by the trading systems.
3. The correlation and overlap of drawdowns observed in the data.

The example of gold and platinum demonstrates why we should not stop at labels.

They are both precious metals, but they are not always driven by the same factors. The two strategies also use different approaches and timeframes. They can therefore contribute to trading portfolio diversification, but their value within the portfolio must be assessed by analyzing how they behave when combined.

The right question is not simply: “How many markets am I trading?”

It is: “To what extent do my strategies depend on the same conditions, and what happens when those conditions become unfavorable?”

Answering this question is what allows us to turn a collection of trading systems into a portfolio built on more solid principles.

Frequently Asked Questions

Do Gold and Platinum Diversify a Portfolio?

They can contribute to trading portfolio diversification, especially if the strategies use different approaches, timeframes, and trading conditions. However, because they are both precious metals, they may share certain risk factors. Their actual contribution should be evaluated by analyzing trading system correlation and drawdowns.

Is Trading More Markets Enough to Reduce Risk?

No. Different markets can react to the same events and become more highly correlated during periods of stress. You also need to consider the systems’ trading approaches, their weightings, and how their results behave when combined.

How Do You Evaluate Trading Portfolio Diversification?

You can analyze market drivers, the correlation between strategy results, overlapping drawdowns, simultaneous exposure, and each strategy’s contribution to overall risk.

What Is the Difference Between Market Diversification and Strategy Diversification?

Market diversification concerns the instruments and asset classes being traded. Strategy diversification concerns trading approaches, timeframes, and the conditions each system attempts to capitalize on. Both should be considered when building a more balanced portfolio.

Would You Like to Build a More Diversified Trading System Portfolio?

If you would like to learn how to select and combine strategies based on different markets and trading approaches, you can request a free strategy session with our team.

Together, we will analyze your goals and show you how the Unger Method™ approaches the development and management of a trading system portfolio.

Book your free strategy session using the button below.

Happy trading!