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The Holy Grail by Ray Dalio

Updated: Oct 5, 2023

Ray Dalio is a billionaire investor. He started with nothing and after 8 years of launching his hedge fund "Bridgewater" he made a huge mistake and lost all the money which forced him to start again from zero and in turn taught him a big lesson and changed his attitude about decision making. Today he runs Bridgewater with more than 160 billions in AUM, He uses computers in decision making and to build trading systems, because they are more accurate and can analyze more data and process decisions with no emotions. Bridgewater is one of the largest hedge funds in the world. It made more money for its investors than any other hedge fund in existence and made money 23 out of the last 26 years.

In a published video, Ray Dalio summarizes the holy grail of investing.

Assume you have a system with a 10% average return per year and a 10% risk (standard deviation) per year. The system has 0.25 Return to Risk ratio (R/R Ratio) with a 40% probability of losing money in a given year.

Lots of people think that you have to find the best investments, while that is important, but there is no one best investment or strategy or best system, and no amount of R&D will enhance a system R/R ratio to four times without compromising, but if you add another system with same characteristics, and a different correlation number then you will reduce your risk while keeping the same returns for each system. The more systems (less correlated) you add to the portfolio, the more reduction in the risk you will gain, all while keeping the same returns of each system.

The chart below describes those relations. You can see that by adding 5 systems with 60% correlation, then you reduce your risk by 20%, which translates to an increase to 0.31 Return to Risk ratio and decrease to 38% probability of losing money in a given year. Also notice that adding more systems after the initial 5, with 60% correlations will not add any benefit to the portfolio.

Adding 7 systems with 10% correlation, will help you to cut your risk in half while keeping the same returns for each system.

The stats gets better the more uncorrelated systems you add to the portfolio, and the ultimate combination is combining 15-20 systems with zero correlation, then you will reduce your risk by 80% and enhance your R/R Ratio by a factor of 5 and reduce your probability of losing money to 11% in any given year. There is nothing that can compete with that and that's what I call a holy grail. Like before, notice that by adding more systems with 0% correlation slowly diminishes and reaches zero after 30 systems.

This chart showcase the simple power of diversification by combining uncorrelated systems. The magic happens when you combine 15 to 20 low correlated return streams (trading systems, algo or algorithmic systems) that have good probability of making money and low correlations. That is the ultimate diversification and not what you are fed via the media which is combining tech stocks with defensive stocks and a little of bonds in a portfolio. That is for the sheep, be a wolf and control your destiny and build your own holy grail portfolio.

If you want to learn how to achieve the holy grail portfolio, a risk balanced portfolio then check out my Algo Trading Masterclass, for building robust trading systems without any programming knowledge or previous experience, by using proven building blocks and state of the art software to test and verify every step until assembling the final portfolio.

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