Many discretionary traders swear by risk-reward ratio, as in "The minimum risk-reward ratio for a Forex trade is 1:2."
Do quantative traders use risk-to-reward ratio as well? If so, how do you calculate the minimum risk-reward ratio?
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$\begingroup$ Do you know what the Sharpe ratio is? $\endgroup$ – chrisaycock Nov 6 '13 at 3:11
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1$\begingroup$ Quants do not care about risk-reward, its not part of their job description. Strategists and traders do. $\endgroup$ – Matthias Wolf Nov 6 '13 at 14:33
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$\begingroup$ @Matt Wolf By traders, you mean discretionary traders, not quantative traders? $\endgroup$ – Tom Tucker Nov 6 '13 at 21:57
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$\begingroup$ @TomTucker, with traders I mean anyone who takes and manages risk, someone who signs responsible for profits and losses. $\endgroup$ – Matthias Wolf Nov 6 '13 at 22:39
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1$\begingroup$ @MattWolf Not sure how you define "Quants", but it seems to me that this is at the heart of our field. $\endgroup$ – Shane Nov 7 '13 at 2:40
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Maximizing expected return while minimizing risk is at the heart of the quantitative revolution in finance in modern portfolio theory.
Starting with Harry Markowitz (1952) "Portfolio Selection", a huge portion of quantitative finance is dedicated to refining the ideas around mean-variance portfolio optimization. The objective is to find a weight vector $w$ that will minimize:
$$w^T \Sigma w$$
subject to:
$$R^T w = \mu$$
When evaluating performance, the Sharpe ratio is the most widely used performance measure, and it directly (if a little crude) addresses the trade-off between risk and reward.
$$S = \frac{E[R-R_f]}{\sqrt{\mathrm{var}[R]}}$$
I recommend reading Peter Bernstein's "Capital Ideas" as a gentle introduction to this subject.
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$\begingroup$ if this is "quant" to you then what is not? Portfolio selection and Modern Portfolio Theory (MPT) lies pretty much at the heart of any discretionary and on-fundamentals focused portfolio manager. I guess knowledge of MPT is most likely tested in one of the first interview questions of any junior starting out in the traditional buy-side industry. $\endgroup$ – Matthias Wolf Nov 7 '13 at 3:04
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$\begingroup$ @MattWolf well as surprising as it might sound, you will find a lot of finance professionals who can't write down these "equations". You might consider a lot of people as non-quants for you because of your background and line of work but I'm pretty sure you'd be surprised how quickly you can be considered as a quant in some companies. $\endgroup$ – SRKX Nov 7 '13 at 8:05
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$\begingroup$ @SRXX, fair point which is why I qualified my comment in response to the question above in that it reflects just my opinion and not necessarily a universal view. It is just that I find the term "quant" in general quite overrated. I do not consider myself a quant because I lack a rigorous mathematical and/or statistical background. $\endgroup$ – Matthias Wolf Nov 7 '13 at 8:14
