Trade Universe

Today I want to talk a bit about choosing the markets to trade in. When I first started I admittedly just looked at which structured products are available for which market and then included those markets in my investable universe. That's not a good approach as I quickly realized. When markets plummed in late January, my portfolio went through the bottom. In my quest to diversify, I just forgot about one important aspect: correlation.
So after getting out of many of my positions I took a closer look at my portfolio and decided to reduce the number of markets that I trade. This has the nice side effect that my transaction costs relative to each trade actually decrease but again that's not the main point. My main goal was to decrease the correlation between my markets. I did a very basic calculation of computing the correlation between each market based on daily returns for the past year. Afterwards I started adding markets based on their correlation to the portfolio (I started with mature markets, which admittedly is arbitrary again). As a result I reduced the number of markets that I monitor to 29:

Mature markets: TecDax, FTSE 100, S&P 500, Nikkei 225
Emerging Markets: Nifty 10 (India), MSCI Turkey, MSCI Greece, South Africa, FTSE Vietnam
Metals: Gold, Silver, Platin, Copper, Nickel, Aluminum, Zinc, Lead
Agriculture: Corn, Cotton, Coffee, Cacao, Sugar, Soy Beans
Energy: Natural Gas, Brent Crude Oil
Bonds: Treasury 7-10, Germany10+, Iboxx10+, Euro Corporate

A word about January's performance: BAD... I am confident that the system works, but so far only the MSCI Turkey and sugar future trades are in the money a good bit. Oil has been swinging in between 72 and 80 dollars creating a few wrong signals. Same with the Metals. Let's see if February will be better. My portfolio is definitely set for a bearish month, with short positions in gold, silver, copper, cotton, FTSE 100 and S&P500. There would be a few more shorts but I couldn't find any products that I am allowed to trade for those, which is quite annoying because the soy bean trade my system indicated would have made a nice unlevered profit of about 7.2% minus transaction cost. I will definitely have to look into those restrictions once I have some time after midterms, job applications and my job at the 2010 Winter Olympics...