|
|
|
|
|
|
|
Neal: Tell me about the Sharpe Ratio. |
|
|
|
|
|
|
|
|
Committee: The Sharpe Ratio shows the variability of your rate of return. There is a lot in the literature about better formulas, but the Sharpe Ratio is used everywhere. I find it to be a good starting point in system evaluation. A high Sharpe Ratio is good and implies low variability, while a low Sharpe Ratio implies high variability. |
|
|
|
|
|
|
|
|
Neal: Does a high Sharpe Ratio result in a high rate of return? |
|
|
|
|
|
|
|
|
Committee: No, only the variability of the rate of return is measured. Let me give you some examples. Let's assume you have a system with a 36% rate of return. If this system made 3% every month, then the Sharpe Ratio would be high. If this system gained 10% one month and lost 7% the next, and all the following months had these big swings, the result would be a low Sharpe Ratio. Now let's try another system that has a 12% rate of return. If the system made 1% per month, then the Sharpe Ratio would be high. If the monthly return was up 6% one month, down 7% the next, and continued on with such great variability, the result would be a low Sharpe Ratio. So a high Sharpe Ratio is important for someone who doesn't want a lot of variability in his or her system, who wants a steady rate of return on a month-to-month basis. |
|
|
|
|
|
|
|
|
Neal: What is your cutoff point for a Sharpe Ratio? |
|
|
|
|
|
|
|
|
Committee: I've heard it said that if a CTA (commodity trading advisor) wants to stay in business, then a Sharpe Ratio of 0.7 or higher is needed. This applies to the individual investor. If the investor wants to stay in business and continue trading, then his system needs a Sharpe Ratio higher than 0.7. |
|
|
|
|
|
|
|
|
As I stated earlier, there are other great criteria for evaluating systems, but these two hit the investor right where he's at. |
|
|
|
|
|