Warren Buffett famously stated, “Diversification is protection against ignorance. It makes little sense if you know what you are doing.” For many investors, this quote serves as a rallying cry for focusing on concentrated positions in areas of deep knowledge rather than spreading investments too thin across a wide range of assets. At first glance, this philosophy seems directed at those who excel in traditional stock picking, but its deeper implications extend to the world of systematic trend following and, in particular, Outlier Hunting.

As Outlier Hunters, we operate in an environment where random price noise dominates the bulk of market returns, and our goal is to capture those rare but massive price moves—the outliers—that exist at the tails of the market distribution. To achieve this, we rely on uncorrelated trend-following systems that remain inactive during periods of noise and progressively concentrate capital as outlier events emerge. This is where Buffett’s philosophy intersects with our own: we concentrate on specific market patterns—in our case, the serial correlation of price data—rather than spreading our resources indiscriminately across all market conditions.

Many confuse Outlier Hunters with traders who simply diversify for the sake of capturing random luck. They believe we spread our portfolios across every conceivable market, system, and asset, hoping that unpredictable events, or outliers, will eventually occur. This superficial view misses a key element of our approach. While we may cast our net wide because we don’t know where the next outlier will emerge, it’s far from a random process.

Once we’re on board a promising trade, we don’t just sit back and wait for luck. We use an ensemble of trend-following systems to massively concentrate on the opportunities that show potential to turn into outliers. It’s not about blind diversification—it’s about deploying a rigorous, disciplined approach to concentrate on trades where the real upside lies.

Buffett’s critique of broad diversification aligns with our own philosophy. While traditional diversification reduces risk by spreading investments thin, it also limits upside. An Outlier Hunter’s goal is not to average out risk, but to maximize the potential of rare, fat-tail events—the extreme market moves that make the real difference. Just as Buffett prefers to focus on a few great companies he understands deeply, we focus on a few trades that show the potential for extreme outcomes.

Outlier Hunters do cast a wide net to ensure no potential outlier is missed. We don’t know when or where the next market outlier will occur—it could be in commodities, equities, or even currencies. However, this wide reach doesn’t mean diversification in the traditional sense. Once we’ve identified potential outliers through our systems, we focus our efforts on those trades, concentrating our capital and attention on the trades that offer the highest potential returns.

Our ensemble of trend-following systems helps us determine when to press a trade. We’re not holding a diverse array of positions and waiting for something to happen. We’re constantly monitoring the markets, and when we see an opportunity building momentum—potentially turning into an outlier—we strategically increase our position to maximize the reward potential.

Where many traders use diversification as a crutch to mitigate ignorance of market movements, we take an active, calculated approach to concentrating on trades that matter. This philosophy not only aligns with Buffett’s sentiment but also reflects the reality of outlier-driven markets. The biggest rewards come from maximizing the winners and allowing trend-following systems to ride the fat-tail events that drive significant returns.

Buffett has always emphasized the importance of knowing what you’re doing, and the same holds true for outlier hunting. We don’t need a basket of hundreds of trades to protect us from the unknown. Instead, we use deep market insight and our systems to focus on the few trades that will have a major impact.

Understanding the Two Zones of Market Return Distributions

The market’s distribution of returns can be divided into two distinct regions:

1. The Bulk of the Distribution:
   This is where most price movements occur and where noise and mean reversion prevail. Prices tend to fluctuate randomly, with movements generally reverting to a mean value over time. While some trend-followers focus on these regions, capturing smaller, more frequent trends, this is not where the outliers reside.
2. The Tails of the Distribution:
   This is where we as Outlier Hunters focus. In these fat-tail regions, price moves are rare but extreme, and they are driven by serial correlation, where price movements follow a trend for extended periods. These outliers are not only rare but have the potential to deliver massive returns. This is where the real opportunities lie for those with the systems and discipline to wait for them.

Figure 1: The Two Distinct Regions of the Market Distribution of Returns

The Role of Uncorrelated Trend-Following Systems

To target the tails of the distribution effectively, we deploy multiple uncorrelated trend-following systems, each designed to capture different aspects of market behavior. Systems such as:

• Donchian Channel Breakouts
• Bollinger Band Breakouts
• Keltner Channel Breakouts

These systems operate independently of one another, reacting to different signals and market conditions. This uncorrelated nature ensures that our exposure to potential outliers is not concentrated too early or in the wrong market conditions. Each system has its own criteria for activation, meaning that they don’t all trigger simultaneously, which is critical for maintaining flexibility and reducing risk in highly volatile environments.

Staggered Activation: A Progressive Approach to Capital Deployment

One of the core principles of our approach is staggered activation. When market conditions are noisy and dominated by mean reversion, our systems remain largely dormant. This ensures we’re not expending capital on small, short-term trends that are unlikely to yield significant returns.

As we move into the tails of the distribution, our systems begin to activate progressively. For example, a Donchian Channel Breakout might capture an initial trend as the price moves outside of the normal range. However, we don’t immediately commit significant capital based on a single signal. Instead, we wait for further confirmation from other systems, such as Bollinger Bands or Keltner Channels, which may signal that volatility is expanding and the trend is becoming more persistent.

This phased approach ensures that we gradually build our position as more evidence emerges that a material outlier event is unfolding. By staggering our exposure, we avoid jumping in too early and being caught in a false trend, while also ensuring that we’re fully engaged when a true outlier emerges.

Figure 2: Progressive Concentration into the Orange Juice Trade using an ensemble of Trend Following Systems

One of the most critical aspects of our system is its ability to remain inactive during periods of noise. The bulk of market movements are characterized by random fluctuations and mean-reverting behavior, which means that chasing every small trend can lead to overtrading, higher transaction costs, and increased risk. Our systems are designed to filter out these non-significant moves, remaining dormant until the market signals the presence of a more meaningful, persistent trend.

This patience is key to preserving capital and avoiding unnecessary risk during periods when the market is not offering significant opportunities. By focusing on the tails, we ensure that our capital is deployed only when the conditions are right for capturing the rare, high-impact moves that define outliers.

Why Uncorrelated Systems Matter in Chaotic Regions

The tails of the distribution are inherently chaotic and volatile, meaning that no single system can consistently capture outliers with complete accuracy. The nature of these events is that they are driven by extreme market conditions, which are often unpredictable and can cause even the most robust systems to fail in certain instances.

This is why we rely on multiple uncorrelated systems—some may fail to capture the move, but others will succeed. By deploying a range of models that each respond to different aspects of market behavior, we increase the likelihood that at least one system will successfully ride the outlier trend to its fullest potential. Some systems may activate early and get shaken out by volatility, while others may only activate once the trend has stabilized. The combination of these systems ensures that we can capture as much value as possible from the rare events we target.

How This Approach Mirrors Buffett’s Philosophy

Buffett’s investment philosophy is about concentrating efforts where deep knowledge exists and avoiding unnecessary diversification into areas where uncertainty is high. In our case, this deep knowledge comes from our understanding of serial correlation and the behavior of price trends in financial markets. Rather than spreading capital across a wide range of random opportunities, we wait for specific signals that indicate the presence of an outlier, and we gradually concentrate our resources on those events as they unfold.

Our use of uncorrelated systems and staggered activation is the trading equivalent of Buffett’s strategy of concentrating investments in businesses he understands well. Instead of relying on broad market exposure, we focus on specific conditions—the tails of the market distribution—where the potential for asymmetric returns is the greatest.

Conclusion: Capturing Outliers Through Uncorrelated Systems

The ability to capture outliers depends on a trader’s ability to recognize where the real opportunities lie within the market distribution of returns. By targeting the tails of the distribution, deploying multiple uncorrelated trend-following systems, and using a staggered activation approach, we ensure that we are progressively concentrating our capital on the events that matter most.

This method of systematically filtering out noise, remaining dormant during mean-reverting phases, and progressively engaging in trends of material endurance allows us to capture the highly volatile, fat-tail events that define successful Outlier Hunting. Just as Buffett focuses on concentrating his investments where his knowledge is greatest, we concentrate on the tail regions of the market distribution, leveraging the insights gained from serial correlation to capture the market’s most significant moves.