I use a trend-following approach where I look for trends in various currency pairs such as GBP/USD or EUR/USD and then take a position in the Spot currency. I measure the performance of my strategy by looking at the ratio between the % returns of my trades and the standard deviation of the returns of those same trades. A positive ratio above 0.2 actually leads to excellent returns over a long period of time.
Someone suggested to me that rather than following one pair, I should take one base currency such as GBP or EUR and generate some kind of composite average (like the US Dollar Basket) and search for trends in that. Once I have signal, I should then take positions in the Spot with the USD and other crosses eg. for GBP it would be 50% GBP/USD + 25% GBP/EUR + 25% GBP/JPY. It was suggested that this would improve my returns/volatility metric (ignoring the fact that non-USD crosses generally have slightly higher spreads and transactions costs than major FX).
Why is this? I understand diversification but I thought that the idea was that you combined positively expectant strategies which were poorly correlated with each other to diversify. Here, you are just combining random currency pairs where you have no particular evidence whether its going to move favourably for you or not. eg. your research signal indicates GBP will move up, but doesn't say EUR/JPY/USD will move up. So essentially you are just dampening down your returns - but if I wanted to do that, could I not just take a smaller position size?