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I agree with Alex's assessment of Sharpe ratio. The entire point of active
trading is to create an asymmetrical (i.e., positively skewed) distribution
of returns, so using volatility around both sides of the mean as a risk
measure will perversely penalize strategies that generate positive skew.
Furthermore, when we look at the financial markets we realize that we are
not dealing with a Gaussian distribution---we are dealing with something
else, most probably a stable Paretian distribution. In a stable Paretian,
variance is undefinable.
High Sharpe ratios can be created---temporarily---merely by naively selling
fairly-priced options. During times of relative market dormancy, the
strategy will appear virtually "riskless;" then one day the music stops and
the options-seller (more specifically, his clients) are left without a
chair.
Just my $.02.
Sebastian Pritchard
----- Original Message -----
From: "Alex Matulich" <alex@xxxxxxxxxxxxxx>
To: <omega-list@xxxxxxxxxx>
Sent: Thursday, January 22, 2004 12:28 PM
Subject: Re: Re[2]: What Constitutes Acceptable System Performance?
> Gabriel,
>
> >I do not see what is so wrong with upward volatility. I can see in the
> >extreme case that you have one trade that makes >60% of your returns
> >over a long time frame you may not want to trade it. But what if 10 out
> >of 100 trades make 90% of your return, depending on how bad the
> >drawdowns are, this strategy seems fine to me. Incidentally, Alex's
> >website is amazing and anyone interested in this topic should definitely
> >check it out and save themselves a lot of time and effort. Thanks Alex.
>
> You're welcome. Incidentally, not everyone
> agrees with my assessment of the Sharpe Ratio on
> http://unicorn.us.com/trading/expectancy.html -- in particular some
> whom I consider experts more knowledgable than me. I think it comes
> down to a matter of opinion of what constitutes a better trading
> system: one that maximizes equity growth per dollar risked, or one
> that has the most consistent returns.
>
> In the extreme case of a system that has no losses whatsoever, you'd
> get a lower sharpe ratio on a system that consistently has variable
> returns higher than the risk free rate, compared to a system that
> has low non-varying returns. Either system has no downside risk,
> yet the one that grows your equity the fastest is penalized. To me,
> this doesn't make sense.
>
> -Alex
>
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