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The Sharpe Ratio is the first measure I look at when analyzing and assessing a backtest results. It is a simple and quick way to measure the performance of a trading strategy.
While this ratio is often used to measure the excess return per unit of risk of an investment or trading strategy, I am using it, in this trading system, to measure the return per unit of risk (risk premium) of single stocks.
The trading strategy buy rule consists of calculating the 90-Bar Sharpe ratio of a list of stocks and then taking only the top 5 (The five stocks that have the highest Sharpe ratio over the last 90 bars). The list of stocks contains all stocks in the universe that have a close price higher than 2 and a 90-Bar rate of return lower than 50.
In addition, the trading strategy includes a market timing rule that prevents it from taking any position if the average 90-Bar Sharpe ratio of all stocks (>$2) is lower or equal to 0.1. This market-timing rule greatly improves the system performance by decreasing its maximum drawdown to -11.1%, increasing its annual return to 38.26% and its Sharpe ratio to 1.81. The backtest or simulation was performed using a portfolio with a maximum number of positions of 10 and a period that spans from 2001 to 2011 (10 Years of EOD data).
As a sell rule, Sharpe ratio was used again. This rule consists of selling any stock whose 90-Bar Sharpe ratio becomes lower than 0.5. A 50-Bar N-Stop was also added to the trading strategy to allow new winners to be picked quickly.
