Case Study, Priya: Three Copy Providers and One Bad Week

[Fairman]

Case Study, Priya: Three Copy Providers and One Bad Week

Priya is a composite character. She allocates 9,000 dollars equally among three copy trading providers, 3,000 each. Their stated maximum drawdowns are 12, 18, and 25 percent, from different histories. Their strategies include a trend follower, a grid trader, and a news scalper. She believes the diversification protects her.

Compute the worst case if all three hit their stated maximum at once. 12 percent of 3,000 is 360. 18 percent is 540. 25 percent is 750. Total: 1,650 dollars, which is 18.3 percent of her 9,000.

That is the stated figure. Real maximum drawdowns tend to exceed history, so a margin of 1.5 times gives about 27 percent, 2,475 dollars.

Now examine correlation. The grid trader and the news scalper both lose in strong, one-way markets or during volatile spikes. A week with a big surprise from a central bank could push both to losses together, and the trend follower may also be caught in a reversal. The diversification may be weaker than she thinks.

Look at the grid. A grid has an unbounded tail. The stated 18 percent may reflect a period without a sustained trend.

Fees and execution delays reduce results from the providers' own track records.

What would a prudent allocation look like? Cap the total at an amount she can afford to lose, say 25 percent drawdown on capital allocated, set an overall stop, and avoid grid and martingale providers unless their tail is clear.

Exercise: compute your worst-case loss if every provider you copy reached 1.5 times its maximum drawdown.