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Measure Correlation Portfolio Diversification Trading Strategy

Using Performance Metrics in the Optimisation Process

Performance Metrics are a great way of comparing different strategies. We wrote about some of these performance metrics in a previous post.

But is it possible to use performance metrics in the optimisation phase of strategy development? A performance metric is just a way of measuring the success of something. So, it makes sense that you can use performance metrics to measure the performance of a strategy and the components of the strategy.

Experiment

It’s healthy for Traders to explore new ideas and ways of implementing those ideas. Trading Strategy Development can be a creative process. Just because an idea is unique doesn’t mean it will be a success, but you only learn what works by first learning what doesn’t work.

It is also a good idea not to limit yourself to one idea or process. You should perform a range of comparisons and see which one looks the most robust.

Question why you think it works and the others don’t. By constantly trying new things and questioning the results, you will improve your understanding.

This process is helpful because the more you understand, the better equipped you’ll be to adapt to an ever-changing market.

Martyn has provided an example of using Van Tharp’s SQN in the optimisation process instead of comparing trading strategies. Similarly, Darwinex supplies various proprietary metrics that can help a trader analyse and optimise their trading strategy.

Do you use Performance Metrics in the Optimisation Process? Let us know how you get creative on Twitter @Darwinexchange.

Brought to you by Darwinex: UK FCA Regulated Broker, Asset Manager & Trader Exchange where Traders can legally attract Investor Capital and charge Performance Fees.

Risk disclosure:
https://www.darwinex.com/legal/risk-disclaimer


Content Disclaimer: The contents of this video (and all other videos by the presenter) are for educational purposes only and are not to be construed as financial and/or investment advice.

Correlation Portfolio Diversification

The Van Tharp SQN and other performance comparison metrics

The Van Tharp SQN is a trading metric designed to ascertain the quality of a trading strategy. Now, there are many ways to do this. You can use

  • Total returns
  • Profit Factor
  • D-Score
  • Risk-reward ratio
  • Sharpe ratio
  • Win ratio & Avg win/loss
  • Max drawdown

The list could go on, but you get the idea, there’s a lot. So what makes The Van Tharp SQN any different or even better than any on the above list. This post looks at the following four metrics and dukes them out against each other.

  1. Profit Factor
  2. Sharpe Ratio
  3. The Van Tharp SQN
  4. D-Score

1. Profit Factor (PF) = (gross profits/gross loss) 

A friendly and straightforward calculation that provides a gauge of the overall performance of a trading strategy. Above 2 is excellent. Below 1 is bad. Between 1 and 2 the trader is somewhere between breaking even and making a small profit.

PF doesn’t factor in the length of the trading history. Suppose you had closed two trades, a win of $50 and a loss of $25, the PF = 2. Two trades are hardly a good indication of the robustness of the trading strategy. 

2. Sharpe Ratio (SR) = (excess return/StdDev of returns)

This metric, created by American Economist William Sharpe in 1966, was designed to measure the risk-adjusted performance of a trading strategy.

Whilst it takes into account the Std Dev (Standard Deviation is the observed deviation from the sample’s mean) of returns. It makes some assumptions in its calculation which can be problematic. You can find more info on this here.

Therefore, the Sharpe Ratio is more involved in its calculations but still doesn’t comprehensively address the problems in its design.

3. SQN = (Expectancy/StdDev(R-Multiples) * sqrt number of trades (capped at 100))

The Van Tharp SQN looks to solve some of the problems with the PF and SR metrics above. Using a time input, The Van Tharp SQN looks to prioritise trading strategies with a more extended and, thus, more reliable trading history. 

By also using the StdDev of R-Multiples, it also aims to prioritise consistency in returns. The idea behind this is that a trading strategy with better consistency in its returns will be more reliable. 

4. D-Score = As this is a proprietary tool created by Darwinex for use on the Darwinex platform, the exact formula is not available. 

The D-Score looks to rank the quality of the returns of a DARWIN over the last five years. It looks at factors such as positive returns over the medium term, the momentum of returns and some of Darwinex’s other Investible Attributes. 

It is easily the most comprehensive performance metric here. The downside is that it is only available for use on the Darwinex platform, but given the breadth of assets you can trade on the Darwinex platform, it really adds value. The upside is that Darwinex has done all the hard work to create trading metrics that allow you to make informed decisions.

Back to The Van Tharp SQN

Given that the primary use of The Van Tharp SQN is to measure the quality of a trading strategy and thus allow an accurate comparison of different strategies.

Only the D-Score beats it. But as the D-Score isn’t available for use outside of Darwinex, the SQN offers a healthy alternative. 

Unlike PF and SR the SQN considers the size of the data set as a determining factor of the quality of the result. Another thing that makes the SQN interesting is that Van Tharp amends the formula to account for vastly different size data sets. 

If he can do it, what’s to stop you from doing the same. Much of trading is trial and error. You could explore a tiered system. Whereby you set different thresholds for different quantities of data.

You can even use the Van Tharp SQN to consider the benefits of varying trading parameters during your optimisation process. 

Why not have a play with the formula, and let us know how you get on @Darwinexchange 

Brought to you by Darwinex: UK FCA Regulated Broker, Asset Manager & Trader Exchange where Traders can legally attract Investor Capital and charge Performance Fees.

Risk disclosure:
https://www.darwinex.com/legal/risk-disclaimer


Content Disclaimer: The contents of this video (and all other videos by the presenter) are for educational purposes only, and are not to be construed as financial and/or investment advice.