I see why sharpe of 3 is so desirable

Discussion in 'Strategy Development' started by SabreMan, Jun 24, 2018.

  1. SabreMan


    I only have a very basic understanding of stats but I think i am understanding why a Sharpe ratio of 3 and above is so desirable.

    My current system i am developing (day trading system) has a sharpe ratio of 2 .
    It makes 50% a year with a standard deviation of 25% (50:25= sharpe ratio of 2, im ignoring the risk free rate)
    As i said my understanding of stats is pretty basic but i think this means that 99.73% of my annual returns should fall between -25% and +125% (50%+/- 75%). As 3 standard deviations of 75% each side of the mean.

    Now if my system had a Sharpe ratio of 3, the same 50% a year return but with only 16% stddev. Then the 99.73% range for the yearly returns would be 0% to 100% a year. That would mean no losing years, ever!

    On the other hand a sharpe ratio of 1.0 would be quite bad eg 50% a year with 50% stdev.
    This means my returns could fall anywhere between -100% and +200% a year.
    So you would have to use a really low risk size with a sharpe of 1.0
    Last edited: Jun 24, 2018
  2. truetype


    Once you're trading real money you'll be happy just to get the sign of your returns right.
    MaxPastukhov, SteveH, alfa8 and 6 others like this.
  3. SabreMan


    I been trading 13 years, have been profitable 10 of those but 3 i lost money.
    I never used to consider the Sharpe ratio or Stdev of my systems, i just looked at the back test to get a feel for the expected range of annual returns.
    Last edited: Jun 24, 2018
    truetype likes this.
  4. SabreMan


    Thinking about it a bit more, a Sharpe ratio of 2.0 is also pretty good because in theory i should only have a losing calendar year about once in every 40 years.
    Last edited: Jun 24, 2018
  5. In theory...In reality a have some guys with the backtested bloomberg 40 years worth of data with the 2+ Sharpe, yet strugling to return 20% per year.
    jys78 likes this.
  6. SabreMan


    You just said 20% without mentioning their draw downs and consistency, they could still have a Sharpe of 2+ with even a 15% return, as long as the drawdowns are low and the return range is not too volatile.
    But i know what you mean, they are probably performing no way near as good as the back test indicated.
    Last edited: Jun 24, 2018
  7. DD is around 5-6%.But your correct, the performance is somewhat below par.
  8. I would feel uncomfortable trading anything less than 4 or 5.. takes too long to see if the edge is still working or not.
    SPYAlgoTrader likes this.
  9. Palindrome


    This is 12 months of data pulled from my IB account. How was my Sharpe Calculated? I returned about 64% in 1 year time frame, it's saying my Standard Deviation is 0.98%. not sure how it was derived:

    AlphaTango and MoreLeverage like this.
  10. SabreMan


    Thats impressive. 64% with no drawdown greater than 4%, world class performance there!

    Your mean daily return (over 261 trading days) was about 0.25% (64/261).

    The standard deviation would be from your daily change in PnL.
    0.98% means most days your PnL was between -1.75% and +2.25% (2 standard deviations from your mean).

    I think your daily Sharpe can calculated by taking 0.25% (less the daily risk free rate) and then dividing it by 0.98. Finally multiplying it by the square root of the number of days, 261 in this case.

    So daily sharpe ratio=(64%/261-RFR%/261)/0.98*SQRT(261)

    If you dont mind me asking, which markets do you trade and what kind of strategy (generally speaking, im not asking for specifics or any secrets).
    Last edited: Jun 25, 2018
    #10     Jun 25, 2018