The Demon’s Alpha: Shannon’s Demon (Volatility Harvesting)
The Demon’s Alpha: Shannon’s Demon (Volatility Harvesting)
Making money from a coin flip. How to mathematically extract profit from pure volatility without predicting the market’s direction.
Executive Summary
- The Paradox: Imagine an asset that doubles (+100%) one year and halves (-50%) the next.
Start: $100 → $200 → $100.
Buy & Hold Return: 0%. The asset went nowhere. - The Demon’s Fix: Now, imagine you rebalance 50% into Cash every year.
Year 1 ($100): Invest $50 / Cash $50. Asset doubles → Portfolio $150. Rebalance to $75/$75.
Year 2: Asset halves. Portfolio $112.5.
Result: +12.5% Profit. You made money from an asset that had 0% return. - Volatility as Fuel: This implies that Volatility is a source of return, not just risk. The more volatile the asset (e.g., Bitcoin), the higher the “Rebalancing Bonus” you can harvest.
The Friction Tax
In theory, continuous rebalancing maximizes this effect. In reality, Transaction Costs (Fees & Taxes) kill the demon. This strategy works best in tax-advantaged accounts (IRA/401k) or with assets that have low trading fees (e.g., Crypto Spot, Liquid ETFs).
Mechanic: Geometric Compounding
Rebalance
Buy Low / Sell High
Uncorrelated
Pair Selection
High Vol
Required Fuel
Critical Enemy
Simulation: The “Choppy Market” (Sideways High Volatility)
Profit from “Noise”
| Feature | Trend Following (CTA) | Shannon’s Demon (Rebalancing) |
|---|---|---|
| Market View | Needs a Trend (Up/Down) | Needs Volatility (Choppy is good) |
| Mechanism | Ride Winners / Cut Losers | Trim Winners / Buy Losers (Contrarian) |
| Ideal Asset | Momentum Stocks | Crypto, 3x Leveraged ETFs, Volatile Tech |
“Most investors hate volatility. Shannon’s Demon loves it. It transforms the market’s nervous energy into a steady stream of compound growth.”
Essential Resources
INTERNAL
BMT Playbooks