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# Sharpe Ratio questions

Discussion in 'Trading' started by HFStartup, Oct 3, 2011.

1. ### HFStartup

Hello.

Below, I have run through the calculations of the Sharpe ratio based on my monthly returns. The value is very low and I would welcome any constructive guidance on if my math is correct and if so, what are the major contributing factors for the low value. For example, I trade with equities and options and I am wondering how the sporadic cash flows might affect this ratio. Thank you in advance for your assistance.

My fundâs monthly returns for 2011 are as follows:

JAN -1.87%
FEB -0.45%
MAR 0.39%
APR 1.16%
MAY 1.69%
JUN -0.90%
JUL 0.61%
AUG 1.36%
SEP -1.49%

My understanding of the formula for the Sharpe Ratio is:

(AVG MONTHLY RETURN â MONTHLY RISK FREE RATE) / (STANDARD DEVIATION OF ALL MONTHLY DATA)

The calculations I made provided the following results:

THE AVG MONTHLY RETURN = .0006

MONTHLY RISK FREE RATE= Based on an assumption of 2%, divided .02 by 12 months or .0017

STANDARD DEVIATION OF ALL MONTHLY RETURNS= .0129

If I substitute these results back into the formula, I get:

(.0006 - .0017) / .0129

Or

A Sharpe ratio of -.09

Thanks again.

2. ### Martinghoul

A 2% annual risk-free rate?

3. ### HFStartup

I went back on forth on which rate to use. What would you suggest?

4. ### Martinghoul

Well, the yield on the current 12m t-bill is smth like 10bps, i.e. 0.1%.

5. ### HFStartup

Originally, I was going to go with a rate similar to one you suggested. However, I went with the higher rate as a conservative estimate and this is one of the issues that has caused my internal debate...I suppose it is always best to accurately reflect current conditions as much as possible.

When I make the calculations based on the risk free rate = .001 this brings my Sharpe Ratio up to .04. Still very, very low.

6. ### heech

With all seriousness... Your returns are barely green for the year (just eyeballing it, less than +1% over 9 months). What kind of Sharpe were you hoping for, regardless of the rf rate that you use?

7. ### Ghost of Cutten

Your problem is lack of profitability, not volatility. So it's a total waste of time working on your sharpe ratio, work on improving your returns and trading ideas/strategies instead.

Remember, performance is king. Volatility can be adjusted at will, simply by increasing or decreasing your trading size. Performance is a lot harder to achieve, but that's where your profits will come from.

8. ### HFStartup

Very good points! Its funny you mentioned this because I have been performing an analysis of increased leverage and found that 2x leverage is optimal in balancing the drawdown with returns. I am in the process now of increasing my position sizing as opportunities permit.

Thanks to all who posted!

9. ### heech

Increasing leverage will not increase your Sharpe. It will double both your gains and losses.

10. ### dtan1e

just out of curiosity, the US debt rating is no longer risk free as defined in the Sharpe ratio?

#10     Oct 6, 2011
ET IS FREE BECAUSE OF THE FINANCIAL SUPPORT FROM THESE COMPANIES: