Quote from man:
are you sure you are talking about annualised sharpe? annualised return divided by annualised std? if not, multiply your figure by 3.4, then it makes more sense.
annualised 0.4 would imply unbearable vola at your return level. so i assume you actually trade a mod sharpe of 1.3, which is quite okay for the time we are in.
This statement is incorrect. There is no way to annualize a sharpe ratio without knowing the average number of trades per year. Roughly speaking when small sharpe ratios are annualized it might increase with the number of trades per year. But if you want to be more precise this is no good.
This brings us to E.Thorpe on two counts. First, his book "Beat the Dealer" in which he revealed the system for blackjack: yes thats right he is the inventor of card counting. He is also inventor of quantitative convertible arbitrage in his 1968 book "Beat the Market". His hedge fund was also the first to put to use pure statistical arb around 1980.
Anyway, in the book there is plenty of time-tested wisdom about mathematical expectation versus the real results. If you cannot get the book, or dont trust me that blackjack has anything to do with what you're trying to do, try to learn about the Kelly criterion which Thorpe advocates using in the market in his paper (can be found at bjmath.com).
http://www.bjmath.com/bjmath/feature.htm
Below i try to summarie the known facts about the Kelly criterion.
The important thing to always to remember is that what you should really care about is the log (the mathematical logarithm function) of your money. Given a sharpe ratio S, the log of your wealth W will grow like:
ln(W) = S^2/2 * N
after N trades. Your money grows exponentially! So greater sharpe ratio increases the best possible growth rate quadratically. But there is a tradeoff, if your optimization reduces the number of available trades in order to increase the sharpe ratio, it may not be worth it.
The above growth rate is only possible if you use leverage L in such a way that given the average profit per trade m and average standard deviation per trade s
L = m/s^2
Unfortunately, as you will surely find this formula asks you to leverage way too much, so you need to use some common sense. In gambling pros use half to a third as much leverage as the above, but in the markets, esp futures markets i prefer to set limit on the maximum acceptable loss instead.
Still , as a practical recommendation optimize the growth rate
g= S^2 * N
this will not harm you, and actually do you good even if you dont use Kelly criterion to optimize leverage.
So, dont overleverage, and good luck,
K
PS unfortunately these formulas are a bit tricky to use, but its well worth it.
