Massive diversification serves as a crucial tool for Outlier Hunters, not only to provide correlation benefits in chaotic regimes but also to increase the chances of capturing rare market events. It is the frequency of these Outliers in the trade distribution that significantly enhances long-term performance. A classic trend follower’s equity curve reveals this lifting power in action. At first glance, the equity curve of a highly diversified trend follower might appear stable and devoid of substantial volatility. A closer look reveals that the true lifting power resides in the Outliers.
Unveiling the Power of Outliers
The results shown are derived from a massively diversified trend-following backtest, not from real trading. This theoretical model portfolio aims to convey the core principles of Outlier Hunting. The model portfolio comprises 35 markets. While the aim is to diversify across hundreds of uncorrelated markets, this 35-market example illustrates the mechanics of Outliers clearly. Each market is traded using 10 uncorrelated trend-following models, each following the Golden Rules of cutting losses short and letting profits run, but specifically designed with different entries and exits to spread the benefits of Outliers across the time series and reduce clustering effects.
A Superficial Glance at the Portfolio Result Over 24 Years
Refer to Figure 1, which displays the uncompounded portfolio result for the 35-market portfolio using a standard $500 risk per trade. There were 11,252 trades made with 10 trend-following systems across 35 markets. The red line represents the daily equity reading of the portfolio, and the blue line indicates the realized balance of the portfolio. The blue line, our capital line, is preserved at all times to limit drawdowns. In a positively skewed trade distribution, the red line tends to sit above the blue line, signifying unrealized equity.
Figure 1: 35 Market Equity Curve using 10 Systems Per Market
If you examine Figure 2, which is the last few years of the equity curve presented in Figure 1, you will see that at the end of the test period, where the red line reaches its peak, we were managing approximately $600K in unrealized equity. This substantial figure was predominantly driven by a successful trade in Cocoa. This example vividly illustrates the essence of trend following: the ability to let profits run and allow unrealized equity to grow to extreme levels when capturing significant market movements, often referred to as ‘riding the tsunamis of the seas.’
Figure 2: Zooming into the end of the Equity Curve of Figure 1
Trend following identifies and capitalises on significant market trends by taking positions in the direction of the trend and holding them for as long as the trend persists. This method inherently results in the accumulation of unrealized equity, particularly during periods of strong and sustained market movements. The $600K in unrealized equity observed at the peak of the red line in Figure 2 demonstrates the power of this approach. By not cutting profits short and allowing trades to run their course, trend followers can achieve substantial gains from a single market event. The Cocoa trade exemplifies a classic Outlier event: a rare, significant market move that generates disproportionate returns relative to other trades in the distribution.
Unrealized equity is crucial to the long-term success of trend following. Unlike realized profits, which are booked and can no longer contribute to future growth, unrealized equity continues to provide potential for further gains, allowing the portfolio to benefit fully from ongoing trends without the premature constraints imposed by closing positions too early. Protecting the realized balance from sharp reversals is a non-negotiable discipline. Trailing stops and other risk management tools serve this purpose, locking in the compounding base while allowing the unrealized equity to continue growing as the trend extends. The Cocoa trade and the $600K in unrealized equity at the end of the test period underscore the core philosophy: capturing Outliers and riding them to their full potential. Figure 3 revisits the equity curve with two additions, a regression line and a comparative benchmark representing an equivalent-sized portfolio applied to a buy-and-hold strategy in the S&P SPY ETF over the same period.
Figure 3: Revisiting the Portfolio Equity Curve with a few Additions
At first glance this appears to be a standard equity curve seen in many backtests: a linear, ascending curve with minimal volatility. A deeper look reveals more. The portfolio result deviated from the regression line post-GFC and only recently returned to it, underscoring the impact of the decade-long winter for trend followers. Despite this, heavy system diversification minimised the impact, allowing the realized balance to continue growing. The realized balance stagnated for only 269 days, as marked on the chart.
The most significant observation is the lifting power of the portfolio relative to the benchmark. The equity curve dwarfs the benchmark performance with materially lower adverse volatility. This is the essence of classic trend following. The acceleration of this lifting power is driven by the ensemble of trading models in the example. Each model is designed to produce uncorrelated results per market, enhancing the probability of extracting an edge from Outliers. This approach allows more correlated markets to be traded because the uncorrelated system suite breaks down existing market correlations, amplifying the benefits of diversification.
A common question is why not allocate a sizeable portion of capital to mean reversion rather than focusing on 100% trend following. This chart holds the answer. Investing in a smooth equity curve that sits in line with or slightly above the benchmark, simply to seek the best of both worlds, comes at a direct cost. Given what 100% Trend Following portfolios can deliver under maximal diversification, allocating a sizeable portion of that capital to a strategy that dilutes returns in exchange for smoothness is a compromise of the lifting power the Trend Following portfolio provides. The optimal deployment of capital is always towards further diversification in the hunt for Outliers.
Diving Under the Hood to See How Smooth it All Is
Understanding the lifting power within the portfolio requires deconstructing the results observed in Figure 3 and examining the contributions of each of the 35 markets.
Figure 4: Examining the Portfolio Constituents and their Contribution
While this example focuses on 35 markets, there are many more Outliers within the portfolio composition than those featured here. In this sample, over 20 material contributions drive performance, as illustrated by the histogram of trade results. Expanding to 300 markets using the same models, the frequency of Outliers would remain approximately 5-10% of trade results, demonstrating the immense potential impact of expanded market diversification.
Returning to Figure 4, peering under the hood reveals that the equity curve is far from smooth. The apparent smoothness in the compiled portfolio result arises from the way individual contributions aggregate due to their uncorrelated properties. The significant lifting power in the portfolio comes from the non-linear contributions of these Outliers, massively amplifying the long-term wealth of the portfolio.
Peering Into Significant Outliers
Seven illustrative Outliers from the series are examined below. Each is unique and explosive in character. Figure 5 shows the performance of Cocoa across 24 years using 10 trend-following models. Below the equity curve, a price chart shows how price movements correlate with performance results. For 23 years, Cocoa contributed almost nothing to portfolio growth, then produced the mother of all Outliers, amplified across all 10 trend-following models.
Figure 5: The Mother of Outliers: Cocoa
Next, in Figure 6, we see an extraordinary contribution from Copper between 2004 and 2006, driven by a perfectly formed trending price series with limited whipsaws. Since then, the market has been relatively dormant.
Figure 6: The Copper Bonanza: High Grade Copper
In Figure 7, we examine an explosive outlier in Corn between 2021 and 2022, with additional lesser outliers in 2011/2012 and 2008/2009. The systems extracted more value from the Outlier in 2021 and 2022 than from previous Outlier regimes.
Figure 7: The Power of Corn: Corn
Figure 8 showcases a massive outlier in Crude Oil between 2021 and 2023, associated with the bull run following its sharp price drop into negative territory in 2020.
Figure 8: The Crude Elephant: Crude Oil WTI
Figure 9 highlights a massive Outlier event in Cotton in 2011.
Figure 9: We Can’t Forget Cotton: Cotton #2
Soybean Oil experienced two large outliers over its time series, with the most significant contribution in 2021/2022 and a lesser contribution in 2007/2008, as shown in Figure 10.
Figure 10: Soybean Oil
Finally, Figure 11 presents the famous Orange Juice (OJ) outlier, which continues to run today with many models capturing its trends. 
Figure 11: The OJ Squeeze: Orange Juice
These contributions highlight the unpredictable nature of Outliers. They can arise at any moment without warning, driven largely by endogenous factors within the financial markets themselves. Their occurrence can often be rationalised in hindsight. Anticipating them in advance is not possible. That impossibility is precisely why diversification across markets and models is the correct structural response: the Outlier Hunter cannot know which market will produce the next extreme move, only that the portfolio must be positioned across enough markets to capture it when it arrives.
Stripping Out the Material Contributions from Outlier Events
The lifting power of the portfolio results is driven by the non-linear Outliers arising in the tails of the return distribution. To examine what happens when these contributions are tamed, a portfolio of 28 markets stripped of the dominant Outlier contributors, Cocoa, Copper, Corn, Crude Oil, Cotton #2, Soybean Oil, and Orange Juice, is compared against the full 35-market portfolio. Figure 12 shows the portfolio equity curve comparison.
Figure 12: Portfolio Equity Curve Comparison (35 Mkts Vs 28 Mkts Stripped of dominant Contributors)
Figure 12 shows that portfolio performance increases by 65% through the inclusion of the seven markets with the most significant Outliers. A reduction in the 28-market portfolio is expected given it is seven markets short, and a performance increase of approximately 25% in the 35-market portfolio would be the baseline expectation. The 65% increase is testament to the non-linear impacts that have been discarded in this process. Not only has significant lifting power been lost, but the result has been smoothed in the process. It is worth noting that Outliers still exist in the 28-market portfolio, but their material positive impact on the overall result is substantially reduced, which is why the portfolio exhibits a far smoother curve with a higher Sharpe Ratio. The 28-market equity curve carries a Sharpe Ratio of 2.66, which might suggest to a reader relying on conventional metrics that it is the better portfolio for compounding. It is not. The raw 35-market portfolio achieves a materially higher uncompounded equity result despite its lower Sharpe Ratio of 1.80. The Sharpe Ratio penalises beneficial volatility, and removing the dominant Outlier contributors is precisely what has been done here.
The shortcomings of the Sharpe Ratio as a performance measure have been discussed elsewhere on this site. The more critical issue is the debate between letting profits run unbridled, as classic trend following requires, versus approaches that aim to tame volatility through volatility targeting or correlation management. Markets do not offer opportunities at all times. The dominant drivers of performance are unpredictable anomalies that are not always present. Continuously adjusting portfolio volatility through dynamic position adjustments based on volatility targets or correlation analysis risks interfering with the Outliers that are the primary source of a trend follower’s long-term returns.
The analysis is unambiguous: tampering with unrealized equity significantly hinders long-term wealth prospects. The central message is straightforward. Do not tamper with unrealized equity. It drives the compounding base and concentrates the portfolio’s exposure towards capturing Outliers. Figure 13 demonstrates the impact on the portfolio’s positive skew when the major Outlier contributors are removed.
Figure 13: Histogram of Results for 35 Market Portfolio Vs 28 Market Portfolio
Figure 13 supports the argument that tampering with unrealized profits drastically reduces long-term wealth prospects and diminishes the positive skew of the portfolio, a hallmark of classic trend following and a primary reason for its effectiveness as a diversifier in traditional portfolios. Maintaining the integrity of unrealized equity is not a stylistic preference. It is a structural requirement. Any attempt to manage or tame it erodes the lifting power that Outliers provide, weakening the geometric return outcomes of the portfolio in the process. The non-linear dynamics that Outliers bring to a trend-following strategy are not a side effect to be managed. They are the source of the strategy’s long-term compounding advantage.
The histograms in Figure 13 make the central point with precision. Removing the seven dominant Outlier contributors narrows the right tail of the distribution, reduces positive skew, and produces a smoother equity curve with a higher Sharpe Ratio. By every conventional metric, the 28-market portfolio appears superior. By the only metric that determines long-term wealth, the compounded terminal result, it is materially inferior. Outliers are not incidental features of a trend-following portfolio. They are the mechanism through which lifting power is generated. The strategy exists to find them, hold them, and allow them to run. Any process that interferes with that, whether through volatility targeting, correlation management, or premature profit-taking, is not refining the strategy. It is dismantling it.