Trading performance measurement. The necessary tools and metrics.
Presenting the necessary tools to evaluate your trading.
One particular question arises after applying a trading strategy is, how good is it? The goodness metric is reflected through three characteristics:
- Consistent low-volatility returns;
- Stable accuracies through time;
- Economically intuitive robust features;
We will discuss the three characteristics and present some performance and evaluation metrics. After all, we do not want to get excited about a strategy that outperformed during a certain period of time by luck, we have to make sure that it is valid for different periods of time and different values.
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The Book of Trading Strategies
Amazon.com: The Book of Trading Strategies (9798532885707): Kaabar, Sofien: Books
Consistent low-volatility returns
A strategy that produces volatile results is not a desirable one. It is preferred that the strategy can handle different market fluctuations and regimes and not provide a 28% return on a period only to give out -54% the next one. The difficulty here is assessing how well in the future will it be consistent, and the most efficient way to address this is through time series cross validation and calculating the standard deviation of these results (when dealing with systematic strategies).
Stable accuracies through time
This concept is extremely important as it shows how well the strategy is doing on average. You can have a fantastic accuracy of 64% but on another back-test you get 31%. With random-like financial time series we are interested on average in a stable accuracy of between 52% — 54% with a risk reward that is at least around 1.8–2.0 as that will also give us a margin for when transaction costs…