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Answer to cwest:
System A and B have the same profit and the same SR. However, System A is
superior to system B. For example, in Figure 18-1(a) System B has much
larger drawdown than system A.
Note: If you want to be a successful trader, you need books by Kaufman and
Jack D. Schwager.
Let's talk briefly about two cases:
A. Case of newbie trader:
He opens $5,000 account and starts day-trading stock index futures. After
series of small losses, his account balance drops to $2,500.
However, he is lucky, his indicators start working again, and he is
experiencing a series of wins bringing his account finally to $10,000 level.
He declares a victory (for his system similar to system B in Fig. 18-1a) ,
and drunken with success he explores a myriad of performance measures.
All these measures look the same to him. However, SR was developed by
academia, is described in many books, and has a lot of nice features,
so he is stuck with SR.
B. Case of experienced trader:
After trading for 20+ years, his account balance exceeds $1 million. System
B used by newbie trader is absolutely not acceptable to him. A possibility
of $1M profit is very tempting, but a loss of $500K could be devastating to
his retirement plan. SR measure is useless to him, it can serve only as
a starting point of evaluation.. He has to change his attitude in two areas:
B1: He has to utilize (or invent on his own) performance measures
de-emphasizing large gains and paying a special attention to pains /
drawdowns.
B2: The most of trading approaches (for example trend following systems
applied to a large portfolio of futures markets with sophisticated position
sizing) will not meet his performance criteria -- they suffer with too large
drawdowns. He has to discover and use methods offering steady gains and
minimum drawdowns in all market conditions (up, down, sideways). Such
methods exist, for example Options trading.
So, depending on who you talk to, newbie vs. veteran, you have two very
different perspective on trading and performance measures.
DC
----- Original Message -----
From: cwest
To: omega-list@xxxxxxxxxx
Sent: Sunday, December 30, 2007 11:06 AM
Subject: RE: "The Sharpe Engine" My 2008 project
I don't have Kaufman's book, so its hard to respond objectively to his
example. Do the examples result in the same profit, or is one example more
profitable than the other, but both have the same SR?
-----Original Message-----
From: DC010225 [mailto:DC010225@xxxxxxxxxxxxx]
Sent: Sunday, December 30, 2007 8:06 AM
To: omega-list@xxxxxxxxxx
Subject: Re: "The Sharpe Engine" My 2008 project
The divisor in Sharpe Ratio (SR) is and always has been the sd of return
(not prices). Unfortunately, SR fails two of three criteria for good
performance measure as explained in Perry J. Kaufman in "The New Commodity
Trading Systems and Methods", look at pages 390 - 391 in 1987 edition.
Figure 18-1 demonstrates:
1. Figure 18-1(a): Consecutive small losses (bad System B) and alternative
small losses & wins (better System A) are the same according to SR
2. Figure 18-1(b): Large surges of profits (System A) and large losses
(System B) are the same according to SR.
In both cases System A is better than B and SR is not good in distinguishing
them. More details in Jack D. Schwager.
DC
----- Original Message -----
From: John Pretorius
To: omega-list@xxxxxxxxxx
Sent: Sunday, December 30, 2007 8:20 AM
Subject: RE: "The Sharpe Engine" My 2008 project
Dennis
You are quite correct.
Many years ago I was introduced to the ratio by someone who defined it
incorrectly and criticised it as I have just done. I have assumed all
these years that the divisor was the sd of price rather than return. I
then promptly closed my mind to it.
Another fondly held prejudice bites the dust.
John R Pretorius
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