General Topics
Markets
Technical Topics
Brokerage Firms
Community Lounge
Site Support

Discussion in 'Strategy Development' started by AskQuestions, Aug 14, 2006.

1. ### man

the only confusion on sharpe ratio happens in the tradestation reports. everywhere else it seems to be quite clear.

SR = (annualised return - risk free rate)/annualised standard deviation of returns

mod SR = annualised return / annualised standard deviation of returns

"return" can be daily, weekly or monthly changes. i would recommend using daily, since they show the picture clearer with shorter time frames. nevertheless when you calc sharpe on ten years of data, your sharpe derived out of daily or monthly data will show very similar results. which is not the case with just one year if data, since you cut out some vola with the monthly observations.

for the following i use the excel terminology. i hope i don't make a typo ...

you annualise daily returns by "=POWER(1+avgReturn; 256) -1", monthly returns by "=POWER(1+avgReturn; 12) -1".
that assumes that you calculate your returns as a percentage, like: (NAV(t0) - NAV(t-1))/NAV(t-1).

if you calculate your returns as log-returns, like "LN(NAV(to)/NAV(t-1))" then you have to annualise by "avg return x 256" for daily data and "avg return x 12" for monthly.

annualising standard deviation is done by "STABW(hereYouHaveToFillInTheColumnWhereYourReturnsAre)*SQRT(256)" for daily data and the same with "...SQRT(12)" for monthly.

now, since sharpe ratio only looks at daily results, it does not care if you achieve them with high hit ratio and low payoff or vice versa. and think about your personal utility function. sharpe is probably much more similar to it than any other figure. which is the reason why i use it.

#41     Aug 16, 2006
2. ### man

judging system by means of profit factor IS flawed. the higher the frequency of trading the more.

i know a couple of papers that put out the flaws of sharpe ratio. most of them are either completely academic or at least fail giving something better.

it is quite interesting that you accused me of giving wrong information in tghe first place, while you yourself do not really bring up an argument but reference to google. now please put me on your ignore list, you enter mine in a second.

#42     Aug 16, 2006

You're kidding, right? If your understanding of something as simple as PF is so flawed, how can you ever hope to understand Sharpe? It is WELL KNOWN that Sharpe can mislead... even Sharpe himself said: "Sharpe ratios can give a false sense of precision and lead people to make predictions unwisely." So please do remain uninformed so I can take the other side of your trades. And keep me on iggy... at least until you get both of your neurons talking to each other.

#43     Aug 16, 2006

About the only problem I've seen with PF is that it doesn't take into consideration the distribution of trades. If a large chunk of the profits come from the top 10% of trades then the overall results from day-to-day trading will be overly optimistic.

#44     Aug 16, 2006

Would you say that an AM radio has a problem because it doesn't receive FM? PF doesn't try to boil an equity curve down to a single number... it's a very simple measure of profit/loss and that's about it. Useful only as a screen in conjunction with other metrics and certainly not a substitute for looking at an equity curve.

P.S. What you wrote about PF not taking "into consideration the distribution of trades" is also true for Sharpe in a way, because Sharpe penalizes large positive returns.

#45     Aug 16, 2006
6. ### jstox

That's exactly how I use Sharpe and PF, first things I look at when researching. If they don't meet my numbers then I know I'm wasting time going down the checklist.

When I'm done with my checklist and have identified the Holy Grail, then I have to go through my code to find the programming bug.

--jstox

#46     Aug 16, 2006

Don't disagree with anything you've said. I was just trying to understand where man was coming from. I'm always up for learning something new. Perhaps he'll provide a little detail on his problem with pf if someone expressed more interest in shedding light rather than heat on the subject.

As you pointed out the Sorentino ratio is probably a better measure than sharpe due to the performance penalty.

Pardo in his book "Design, Testing, and Optimization of Trading Systems" had a interesting idea for measuring the robustness of a system by using a corr. coeff. between the equity curve and what he called "perfect trader". I've never tried it but it sounds interesting.

#47     Aug 16, 2006
8. ### man

i have the impression that with increased number of trades profit factor at least sometimes is diminishing while all other figures are great. i tested a smooth equity curve with a sharpe of 2, but a profit factor of merely 1.3. on the other hand i have a system with a profit factor of almost 3 with a sharpe of less than 1. if you look at the equity curves you quickly see that your visual impression is literally always in line with sharpe but really not always with PF.

and as i said before. i think as a trader you are finally neither hurt by low hit ratio nor by low payoff but what you really feel is sharpe. give it a second thought.

whenever you enter any pro-shop, what people are really talking about is sharpe. my problem with sortino is that you tend to overweight the importance of a few positive outliers. i saw a presentation of rentec recently: they publish sharpe and return, nothing else.

anyways, there are other ratios that are advanced, i think omega is one of them. that would be a very different discussion. but between sharpe, hit ratio, payoff, profit factor, draw down, MAR ratio, sterling ratio there is absolutely no doubt where the true value lies.

it is just not the ways traders think. look at tradestation reports. all these dollar figures. that is single trader thinking. dollars in an account and not % of capital. that is the main source of difficulty. traders usually think in dollars and not in %, therefore every figure that moves away from dollars is suspsicious. i highly respect that, no offense intended, but when you are talking to a real pro, who is running multiple systems or strategies, you realise they know their sharpe very well. just consider you have one system, than you add another one and another one. how do you measure the overall effect? how much better have you become? consider now you have two additional systems but you can, for whatever reason, only trade one of them. which one do you choose? sharpe (or if you will sortino, omega, what have you) answers this question elegantly. PF, hit ratio, payoff ...?

having said that i respect that it is not by any means necessary to even ever have heard of sharpe to be a wonderful trader.

BTW my problem with all draw down figures is that a single figure out of a whole distribution is statistically weak ... it is interesting. plus, i think that with the overall shape of the return distribution being unchanged, max dd MUST increase over time. so whenever you panick after five years when your system makes a new historic dd you might be in fact observing something inevitable ...

#48     Aug 17, 2006
9. ### inCom

I found recovery factor to be a very useful figure besides Sharpe. It takes implicitly into account not only all the individual trades and their variability, but also the time sequence in which they occurred because max drawdown is considered in it. The same set of trades could have produced a very different equity curve if they had occurred in a different order.

If you look at an EQ curve with a very high RF you can see immediately that it's highly correlated to its linearity.

I found RF to be the best stand alone figure to express the quality of a curve. Alternatively, I look at avg % x trade, % winning trades and payoff ratio considered together. But I like RF best.

To the thread starter: I looked at the EQ curve you posted and it is too jagged to me, I personally wouldn't trade it. And the other system has too few trades, as it has already been said.

GS

#49     Aug 17, 2006
10. ### man

valuable post.

#50     Aug 17, 2006
ET IS FREE BECAUSE OF THE FINANCIAL SUPPORT FROM THESE COMPANIES: