The Diversification Sphere

In the investment world, there are multiple meanings to the word "diversification." It can be applied at the portfolio level just as easily as it can at the individual investment level. In this issue of Investor Notes, we will review both forms of diversification as each one plays a critical role in the construction of a well-rounded investment portfolio. Our primarily focus, however, will center on diversification at the individual investment level as we introduce the Diversification Sphere.

Let's begin our discussion on multi-dimensional diversification with a couple of definitions.

1) Portfolio diversification centers on investing across asset classes such as stocks, bonds, currencies, real estate and commodities. The goal is to combine investments that behave differently over time to lower the volatility of the general portfolio while attempting to maximize returns. [More] 2) Individual investment diversification centers on investment products such as a mutual funds, hedge funds or Commodity Pool Operators (CPOs). These products offer instant diversification across a variety of markets/sectors, trading styles and time horizons. Essentially these products offer diversification within a single investment. [More]

Chart Research Perspective

As a Commodity Pool Operator, we offer our clients the best of both worlds. First when added to a traditional stock and bond portfolio our near zero correlated programs provide investors with some much needed asset class diversification. Second, and perhaps more importantly, our trading programs offer diversification at the individual investment level. We are talking full diversification, since we trade a broad range of markets with a variety of trading systems and across multiple time frames.

To illustrate diversification at the individual investment level, let's take a look at the Diversification Sphere. Our goal is to provide investors with a visual overview of true investment diversification.

When you think of an investment; visualize a three dimensional sphere (Figure 1). The sphere itself is comprised of three axis; X, Y and Z. X represents the horizontal axis, Y represents the vertical axis and Z represents the depth axis (Figure 2). Together these three axes form a sphere.

Figure 1	Figure 2

To create our sphere we will need three types of diversification. The list below relates directly to the Chart Research trading systems.

• X Axis (Global Market): We actively participate in over 40 of the world's largest futures markets. These markets can be classified within eight sectors including; grain, meat, metal, energy, currency, softs, interest rate, and stock index sectors.

• Y Axis (Trading Style): Although we are best described as trend oriented, our 700+ trading systems fall into three categories; trend, momentum and pattern based. Our trending systems attempt to profit from sustained price action. While our momentum based systems track short-term overbought and oversold conditions attempting to profit from quick market reversals. And finally our pattern based systems selectively scan the markets looking for high probability entry and exit opportunities to increase or decrease exposure to individual markets.

• Z Axis (Time Horizon): We trade short, intermediate and long-term time horizons as our systems continually adjust position size for each market over time.
  

Our systematic trading approach allows us to follow strict guidelines across a wide variety of markets/sectors, trading styles and time horizons. A major benefit to our trading approach is the ability to increase the size of our diversification sphere as we continue to add markets and systems into the trading mixture. After all, the larger the sphere the more diversified the investment.

When viewed from a multi-dimensional perspective, it becomes abundantly clear that we offer a fully diversified investment program. Additionally, our trading programs provide asset class diversification at the portfolio level. The bottom line is our programs provide investors with added asset protection no matter how you define "diversification".

Why diversify? . . . The $64,000 question.

If an individual knew with complete assurance that an investment was going to make a major move, there would be no reason to diversify their portfolio. They would simply invest 100% of all available cash into the investment to maximize total return. Unfortunately, in the real world, there is no legal way to know which investment is ready to explode. So quite simply, it's in the best interest of all investors to diversify their assets. The moral of the story . . . put all your eggs in a single basket and you might end up with egg on your face.