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At 11:54 AM -0800 1/6/02, Alex Matulich wrote:
>It seems that the problem you encountered (a high Sharpe ratio for
>result that have a long flat period) might be fixed by the "Sharper
>ratio" described in the Excel spreadsheet at
>http://www.medianline.com/sharperatioexample.xls
>
>The difference between the Sharpe ratio and the Sharper ratio is
>the way they penalize drawdowns versus profits. The Sharpe ratio
>penalizes upside as well as downside volatility. The Sharper ratio
>doesn't penalize profitable periods but does penalize drawdowns (and
>possibly flats; I haven't looked into it).
People have constantly been try to improve on the Sharpe Ratio
without much success. That is because the Sharpe Ratio is
fundamental. Study "Modern Portfolio Theory" and you will see why. It
has a beautiful consistency that is hard to beat. It is an absolute
measure that works on all investments from buy/hold to the most
far-out trading systems.
It is easy to show that the investment with the highest Sharpe Ratio
has the best return-to-risk ratio.
It is also easy to show that the optimum return point for an investor
(the point that maximizes his "utility function") increases as the
SQUARE of the Sharpe Ratio.
Many brokerage houses are making piles of money selling short the low
Sharpe Ratio dumb investments their clients are making and investing
the money in high Sharpe Ratio investments.
I have found that most of the people who want to modify it do not
really understand it and don't like the numbers it gives for their
systems. So they invent something that gives them better looking
numbers...
There are other important considerations of a trading system such as
the tradeability, capitalization required, etc., so people should
quit trying to find the single measure that will tell them if they
have a good trading system.
I would rather trade a system with high tradability and a moderate
Sharpe Ratio than one with low tradeablity (for me) and a high Sharpe
Ratio. But the Sharpe Ratio tells me what I could achieve if I can
trade it.
Just my perspective, of course...
Bob Fulks
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