To recap the last issue, we examined how a system test can be more profitable than buy and hold if it produces greater returns for the amount of time that it spends in trades. The question this poses is, "Even if it spends less time in a trade with fewer returns, how is that really profitable?"

By definition, it's not as profitable as buy and hold, but the potential exists for greater profits all around. These kinds of results are where many fundamentalist investors create claims that market timing is less profitable than a buy and hold approach. If a system was only traded on a single security and using that as a comparison, then they would certainly be right.

But even the majority of buy and hold practitioners believe in some method of diversification, typically executed by spreading their portfolio among several securities instead of keeping it all in one. If buy and hold is a stronger philosophy by nature, then diversification would not be necessary.

What buy and hold fails to recognize is that the philosophy is in fact a market timing approach. A position is entered for the purpose of increasing in value. However, at some point profits (or losses) will have to be realized. If a position is never exited, then any increase in the value of the position becomes worthless. A position only has value once the position is "cashed out" to become useable. (The exception is to enter the position for tax purposes, company control, or for option writing.)

Therefore, the only real difference between an investor and a trader becomes the time frame that each uses. The trader tries to time the market/security between minutes to months usually while the investor times the market/security in years to decades (or until he decides that the position has made enough).

A typical market timing approach 'cashes out' more often than an investment approach giving the trader greater opportunities to change the security being worked with. With this in mind, the trader is in a perfect position for maximizing their returns by diversifying the group of securities traded.

Using this idea, we can then look at asset distribution for the purpose of maximizing profits.

Two basic parameters need to be established for this to become functional; the type(s) of securities used, and the type(s) of trading systems used. Since securities within a specific industry group tend to move in similar patterns, using the same trading system with such like securities tends to cause many of the same signals to be executed simultaneously, or near the same time. This defeats the purpose of moving the assets, since the time that you should be entering one security you find that the capital is already being utilized by another security.

There are two solutions to this problem: to use the same trading system with securities with no relation to one another, or to use different (but still profitable) trading systems for securities within the same group. The purpose is to distribute the trade activity so that when one signal in one security exits you from a position, you can quickly move it into another profitable position, therefore stacking the profitable trades consecutively.

The less time a system has you in any particular security, the greater chance that you will be able to have the financial means for executing a trade in another security. This means that systems that have you in for a minimal amount of time (while still achieving a reasonable profit for time in the trade) have the ability to produce greater overall profit instead of less.

Typically, using this approach allows the trader to work with more securities than usual. The ability to move money freely means that the normal resources required to trade 3 or 4 securities can now successfully be distributed among 9, 10, or more (depending upon the systems used).

For example, assume you have a security that has a total buy and hold profit of 100 points over 1000 trading days. Conversely, you have a trading system on the same security that generates only 33 points for the same 1000 periods of time, but is only actually in a trade for a combined total of 100 days (900 days it is out of the security waiting for the next trade).

This gives your money 900 more days it can be in other securities making profits, assuming that entry signals are being generated in other securities at the same time that your money is out of a trade. You can then move your money temporarily to another winning position in another security until you receive another entry signal into the first security (or maintain the current position if you have reason to believe that it will be more profitable than a position in the first security).

Due to the majority of people’s difficulty in creating a system that can produce profits consistently greater than buy and hold, this kind of active redistribution becomes essential to maintaining a consistently profitable portfolio. This also means that the more capital you have to maintain multiple positions, the more securities you can have while still being able to trade each of their signals.