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Mathematics in trading: Sharpe and Sortino ratios

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by , 04-02-2022 at 01:00 AM (481 Views)
      
   
Return on investments is the most obvious indicator which investors and novice traders use for the analysis of trading efficiency. Professional traders use more reliable tools to analyze strategies, such as Sharpe and Sortino ratios, among others. In this article, we will consider simple examples to understand how these ratios are calculated. The specifics of evaluation of trading strategies were earlier considered in the article "Mathematics in trading. How to estimate trading results". It is recommended that you read the article to refresh the knowledge or to learn something new.
Experienced investors and traders often trade multiple strategies and invest in different assets in an effort to get consistent results. This is one of the concepts of smart investment which implies the creation of an investment portfolio. Each portfolio of securities/strategies has its own risk and return parameters, which should somehow be compared.

One of the most referenced tools for such comparison is the Sharpe ratio, which was developed in 1966, by Nobel laureate William F. Sharpe. The ratio calculation uses basic performance metrics, including the average rate of return, standard deviation of return and risk-free return.
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