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Some people like to use the Sharpe Ratio to gauge the relative
quality of one trading strategy compared to another. After extensive
research, the consensus conclusion is that the Sharpe ratio isn't
useful for objectively evaluating the merit of a system. It does
have uses, but I do not agree that it should be used for determining
overall merit.
Take two extremes for example:
System A returns 0.001% greater than the risk-free interest rate
with zero drawdowns, and perfect consistency.
System B returns 60% per year on your account with modest 10%
drawdowns.
Which system would you rather trade? System A has a higher Sharpe
ratio -- it's actually infinite due to zero standard deviations in
returns. Personally I'll take system B over A any day! I am more
concerned with my equity growth and earning power of my risk
capital, than whether periodic returns are exactly the same.
All the Sharpe ratio does is measure consistency. True, that's one
element of merit, but certainly not the whole picture. Using it to
determine the merit of a whole trading strategy results in
completely erroneous and subjective evaluations, as demonstrated by
the extreme example above.
There's really only one objective way to measure the merit of a
system, and that's how much you expect it to earn for every dollar
risked combined with how often it gives you the opportunity to earn
that expected return. The risk concept is important; you're
measuring the return from your risk capital (i.e. your initial
stoploss), not what you actually "invest" in the market.
Develop a system that has a high expectancy score, and you'll find
that the Sharpe ratio takes care of itself.
Research has led a lot of people down some fruitful paths, and some
fruitless paths. Optimizing for Sharpe ratio is in the latter
category.
rgds, Pal
--- In amibroker@xxxxxxxxxxxxxxx, "Christoper" <manchu@xxxx> wrote:
> I've tried a few indicators, and haven't been able to come close
to
> a Sharpe ratio of 1, let alone positive.
>
> I've read (well ok, tried to understand) the article on the Sharpe
> Ratio plus poked around on the web to understand it a little
better,
> but i don't think things have sunk in.
>
> But even before I try to look at that indicator:
>
> 1 - How do people view this ratio? Do you think it is a weak or
> strong indicator of risk adjusted return.
>
> 2 - I know that 5% is hard coded as a "risk free rate", but at
this
> point in time, isn't that kinda high?
>
> 3 - OR if people know where else I can look to compare and weight
> the various measures ot return that would be helpful.
>
> Thanks in advance!!!
>
> CHris
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