Discussing the article: "Portfolio optimization in Forex: Synthesis of VaR and Markowitz theory"
Thanks for the article - very interesting.... I will re-read it more thoughtfully from my computer....
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Check out the new article: Portfolio optimization in Forex: Synthesis of VaR and Markowitz theory.
I have spent the last three years developing trading robots for Forex. And you know what? Risk management is a real pain. At first, I just set fixed stops until I lost a couple of deposits. Then I started digging deeper and came across Markowitz's portfolio optimization theory.
It looked nice - you calculate correlations, optimize weights... But in reality this does not work very well for Forex. Why? Because in Forex all pairs are interrelated! Try trading EURUSD and EURGBP at the same time and you will see what I mean. One sharp EUR movement and both positions merge synchronously. A beautiful theory is shattered by harsh reality.
Having had enough of this, I started looking for other approaches. Eventually, I came across the Value at Risk (VaR) methodology. At first, I did not even understand what it was - some kind of complicated equations. But then it dawned on me - this is exactly what I needed! VaR shows the maximum loss for a given probability. In other words, we can directly estimate how much money we might lose in a day/week/month.
In the end, I decided to cross Markowitz with VaR. Sounds crazy? Maybe. But I did not see any other options. Markowitz provides the optimal allocation of funds, and VaR prevents from getting into a margin call. It looked great on paper.
Then began the harsh everyday life of a research programmer. Python, МetaТrader 5 terminal, tons of historical data... I knew it would not be easy, but reality exceeded all expectations. This is what I am going to tell you about – how I tried to create a system that actually works, and not just looks pretty in a backtest.
If you have ever tried to automate Forex trading, you will understand my pain. And if not, then maybe my experience will help you avoid at least some of the pitfalls you have to step on.
Author: Yevgeniy Koshtenko