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What should be the value of a Sharpe Ratio for an intraday quantitative strategy to be accepted by a bank or hedge fund's prop desk? Let's assume the returns are daily changes in account equity, close to close.

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A Sharpe ratio of at least 1 in backtesting is a promising start, but that is just one of many statistics of interest. The Sharpe ratio measures return per unit volatility, i.e., return per unit risk. Some other important Sharpe-like measures with different definitions of risk include:

  • Return per unit turnover (aka yield): A high yielding strategy is more desirable in many ways, since it may also require less liquidity, have less market impact, and be less sensitive to transaction cost modeling errors or future regime changes in transaction costs.
  • Return per unit transaction costs: Similar to yield, this gives an indication as to how sensitive the strategy performance is to errors in the transaction cost model, and shows how much of an alpha buffer is available for costs which may be hard or difficult to capture in backtesting.
  • Return per unit max/avg asset exposure: A strategy that is more diversified across assets is less sensitive to event risk, and more likely to have a higher capacity.
  • Return per unit max drawdown: Drawdown is in many ways a better measure of risk compared to volatility. Day to day Gaussian-like volatility is not likely to wipe out the strategy, while a sustained period of losses will. The leverage of a strategy is likely to be backed out from the max drawdown, based on how much the fund is willing to lose.

In addition, any of these numbers are usually not computed just for the entire backtest period, but are instead shown on a rolling basis, to show how consistent the performance is over time, i.e., the performance is not just due to a few lucky trades.

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  • $\begingroup$ Thanks for taking time and answering the question. Is 1+ you're mentioning for intraday trading, say on 5min to 1hour holding intervals, or for longer term tactical asset allocation, with say monthly or quarterly rebalancing? $\endgroup$ – Sergey Bushmanov Oct 9 '15 at 19:46
  • $\begingroup$ As MichaelJ states below, you can usually expect higher Sharpe ratios for higher frequency, higher turnover strategies. For these strategies, yield becomes far more important than Sharpe. But it's a trade-off: a lower Sharpe ratio strategy that rebalances infrequently (daily or higher) is likely to have a far higher capacity, and give potentially higher returns. The devil is in the details, really. $\endgroup$ – mpeac Oct 11 '15 at 21:41
  • $\begingroup$ To be honest, I have difficulty understanding where HFT higher SR's coming from. Volatility on 5 min ticks (i.e. price moves on 5min ticks) is lower than on the daily ticks. So intraday trader yet needs to accumulate profits presumably available to daily traders, let alone costs from trading frequently. I am intuitively drawn towards intraday, but I do not understand how 1+ SR for daily traders become 10+ for intradayers. TA rules are more or less the same, profits lower, costs higher. Why?... $\endgroup$ – Sergey Bushmanov Oct 11 '15 at 22:09
  • $\begingroup$ I think it comes down to the fact that it's easier to make more reliable short-term predictions than long-term predictions, since there is less chance of interference from other factors not captured by the strategy model. In the special case of arbitrage strategies, the distribution of the returns can be almost non-negative, since you either successfully complete the set of trades and lock in a profit, or you don't. $\endgroup$ – mpeac Oct 12 '15 at 1:28
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The required Sharpe ratio depends strongly on whether you are referring to actual profits or a simulation. For actual results, a Sharpe of 1+ over 12+ months is probably the minimum. If the strategy trades liquid markets at liquid times such that it can be scaled up to generate large revenues then, all else being equal, it is more attractive. This is assuming that by intraday you mean just a few trades a day. If it's a high-frequency strategy turning over hundreds or thousands of times per day then Sharpe will likely need to be above four. For high-frequency strategies, if the strategy works the Sharpe is often quite high, routinely above ten. Therefore, larger firms will scrutinize capacity. That is, the total amount of revenue that can be generated from the strategy. There isn't much practical difference between a Sharpe 10 and Sharpe 20 strategy is the latter can't generate any additional revenue.

Simulations are a different matter. Many firms won't hire traders based purely on backtested results, regardless of Sharpe. To break in with a backtest you will need either (1) strong credentials, (2) a really good story to go along with the backtest or (3) experience at another firm that is somewhat successful.

Keep in mind I am talking about respectable firms here. There are a lot of two bit firms out there that will hire anyone off the street and let them start trading with small limits. Those firms won't offer much in the way of training or infrastructure.

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  • $\begingroup$ Michael, thanks!. 10 to 20 for intraday, that's in my ballpark, I've heard 12-14. Do they calculate SR on a daily basis or on more frequent basis? $\endgroup$ – Sergey Bushmanov Oct 9 '15 at 20:16
  • $\begingroup$ I believe that daily is most common. Intraday would require some kind of mark-to-market accounting of open positions, which opens up a pandora's box. Should positions be marked to prices at near-side of book? far side? midpoint? What if the position is larger than the quotes on the top level? Intraday strategies can have high Sharpe ratios while earning less than one minimum tick size per trade so estimates will depend very strongly on the procedure used. There is no such ambiguity for daily profits when not holding overnight. $\endgroup$ – MichaelJ Oct 10 '15 at 15:19
  • $\begingroup$ One more clarification. When you say 10-20 for HFT, is it after costs and accounting for possibility of slippage? 10-20 sounds like a money machine, which can even be safely leveraged. I am wondering how do they achieve this... $\endgroup$ – Sergey Bushmanov Oct 11 '15 at 21:59
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Uh-oh, wrong move.

There's no point looking at Sharpe here.

For a large bank, your job is generally to maximize the gross profit of your desk, because the firm achieves diversification at the operational level (across business units).

It seems that you are thinking specifically about the Sharpe ratio of low latency prop trading. In those cases, it gets to a point that you have enough strategies that you just call it off as "infinite Sharpe" and start worrying about your expenses.

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