In my previous post, I reported an astute observation from my reader Mr. Goldstein that maximizing compound rate of return, maximizing leverage, and maximizing Sharpe ratio are all tightly connected. This makes intuitive sense because the higher the Sharpe ratio of a strategy, the smaller the drawdown, and therefore the higher the leverage you can apply to it in order to maximize compound return.
Mr. Goldstein also made another very interesting observation. He noted that there are usually 2 ways to increase the returns of a portfolio of stocks: either by picking high-beta stocks, or by increasing the leverage of the portfolio. In both cases, we are taking on more risk in order to generate more returns. But are these 2 ways equal? Or is one better than the other? It turns out that there is some research out there which suggests increasing leverage is the better way, due to the fact that the market seems to be chronically under-pricing high-beta stocks. This gives rise to a strategy called "Beta Arbitrage": buy low-beta stocks, short high-beta stocks, and earn a positive return.
I myself have not studied this form of arbitrage in depth, and therefore can neither endorse nor criticize it. However, if this research is correct, it does argue against including too many volatile stocks in your portfolio or trading strategy. If you want to take on more risk and generate higher return, just turn the knob and increase your leverage and therefore book size.