Zebu blog

Tag: Market Conditions

  • What Should You Consider While Backtesting A Strategy – Part 2

    Sharpe Ratio: The risk-adjusted returns, or reward-to-risk ratio, is found by dividing the annualised return by the annualised volatility.
    With the Kindino Ratio, negative returns are taken into account by dividing the annualised return by the annualised volatility of negative returns.

    In the last section, we talked about how volatility was a way to measure risk. We have these two measurements because we know that not all risks are bad. Sharpe looks at all kinds of volatility, while Sortino only looks at downside volatility. Here is where they part ways. Most of the time, you want a high Sharpe and a high Sortino.

    The right way to count costs

    When analysing trading techniques, it’s also important to think about how much it costs to make the trades that need to be made. One of the main reasons for this is that beginners often think their techniques are better than they really are.

    Many quants think that the only costs of a trading strategy are the commissions that have to be paid to brokers. Two more important examples are:

    Commissions

    As you may already know, it’s hard to trade without a broker. In exchange for money, brokers provide transaction services and act as an exchange. Brokers sometimes add on extra costs and fees that you might not expect. This includes any extra services, fees set by the exchange, and taxes the government might charge for the financial transaction.

    Slippage

    Slippage is a key feature that is often overlooked when evaluating. Slippage is when the price you wanted to trade at is different from the price you actually trade at.

    Why do these prices vary from each other? There could be many things going on. For example, you might have wanted to buy 100 shares of Apple at $100 each, but only 50 people were willing to sell at that price and another 50 at $101. Your loss would have been 50 cents, and the price you would have traded at is 100.50.

    Slippage, which is part of transaction costs, can quickly turn a strategy that should be profitable in theory into one that doesn’t work. In the previous example, if you had planned to sell your shares for 102 dollars, slippage would have cut your profit by 25%. Slippage can be reduced by making a good plan for execution, but it’s important to know how it might affect your deals.

    A few words about the biases we all have

    Everything comes from within, including both profit and loss. Even though the market and how volatile it is play a big role in how much money we make or lose, we always let an inner voice guide us when we make a trade. Some of these voices can be helpful, but most of the time they come from people’s biases. We often feel a wide range of emotions and have to make decisions we weren’t supposed to make because of these kinds of personal biases. We need to control our emotions and personal preferences if we want to know when to stop a trade and when to keep going with it.

    We can’t make good decisions when we’re feeling a lot of different emotions, so these are important things to look at when judging a trading strategy. Some emotions that can make it hard to think straight are excitement, thrill, hope, fear, worry, and panic. These are the emotions that drive us, so keeping an eye on them when it makes sense will always help us do better in a trade.

    If you want more information on this, we also have a page about biases in backtesting and risk management. This will tell you more about your own biases and how to avoid them so you can trade better.

    Most of the time, these are some of the things that are used to judge a trading strategy. Don’t be afraid to write things down as you try to use them in your plan. Once you’ve looked at the results, you can start making changes to improve the way your transactions work.

  • What Should You Consider While Backtesting A Strategy – Part 1

    Backtesting is a very useful way to figure out how our trading algorithms might work in real life (might is the key word). But it can be hard for a data scientist who doesn’t have a background in finance to understand what it all means. Sharpies or Sortinos? Returns or profitability with money? This shouldn’t stop you, though, because some of the best funds in the world are run by people who aren’t in finance. Instead, it’s time to learn.

    In this article, we’ll talk about some of the most important ways to tell if your trading strategy is working or not. If you really understand these basic indicators, you’ll have a good basis for judging different strategies.

    Setting Up Performance Measures

    These are some of the first criteria or measures you could use to figure out how well your trades are going. Most of the time, the measurements focus on two important parts of a strategy: the change in the value of the portfolio and the risk of making those gains or losses. By understanding these two things, you can figure out what it does well and where it falls short.

    Financial metrics

    All of the metrics in this section tell you how much money you made (or lost) when you used a certain strategy. The final amount of money is a good place to start, but there are other signs that give us more information:

    Annualized Return: The average annual percent profit from your trading strategy (or loss).

    Win/Loss, Average Win/Loss: Total (or Average) (or Average) Profits from Trades That Work The total (or average) amount of money lost on trades that go wrong.

    % Profitability is the number of profitable trades out of all of them.

    When we talk about return on capital as a percentage, we usually mean that the strategy is a multiplier on your initial capital. This is helpful most of the time, but we should remember that it’s only partly true.

    Next, if we want to fully understand a strategy, we need to know how we are making money. For instance, do we consistently make tiny wins or do we consistently make small wins followed by massive losses? By looking at different combinations of profitability, win/loss, and profit/loss, we might start to understand how our plan will work.

    Metrics that focus on risk

    It’s just as important to see big profits as it is to know that the method could lose money in the long run. “No risk, no reward” is a saying that only winners use. The vast majority of people whose risky bets didn’t pay off don’t say it. Here, the following crucial metrics are important:

    Annualized Volatility: The standard deviation of the model’s daily return over a year. Since volatility is used to quantify risk, a model with a higher vol indicates greater risk.

    Highest Drawdown: The most negative change in the value of the whole portfolio or the biggest drop in PnL. It is based on the biggest difference between the high and the next low before a new high is set.

    Since our backtest will always cover the whole period, drawdown is an important risk factor to think about, but we’re much less likely to keep a losing trade open in real life. If you had bought Amazon stock in 1998, it would have been smart to keep every share and buy as much as you could during the dotcom bust. In reality, not many people would keep going with a deal if their money dropped by 10%, 20%, 40%, 80%, etc.


  • What Impacts The Performance Of A Mutual Fund?

    There are many different mutual fund investments that people can choose from. There are some good reasons to invest in mutual funds, like getting help from a qualified asset manager.

    Investors trust fund managers to choose investments that will be good for their money. If you’re an investor, it’s best to know how fund managers do their jobs.

    Here are a few factors that impact the returns from a mutual fund.

    1. The cost of running a fund

    The expense ratio, which is also called the fund management fee, is a typical fee that the fund house charges investors to cover costs like operating costs, wages, compliance costs, administrative fees, etc. It usually shows how much of the investor’s mutual fund holdings it is. Most hedge fund companies use the 2/20 model, which lets them take 2% of the fund’s AUM as a cost ratio and 20% of the fund’s profits as performance fees.

    2. Window dressing illusion

    Mutual funds sometimes use “window dressing” to hide the fact that they aren’t doing well by making it look like they are. They don’t have to explain what happened to make them perform badly. Before putting money into a fund, a potential investor should carefully look at how the fund has done in the past and how it invests overall.

    3. Indexing as a way to lower risk

    Investors prize fund managers’ stock-picking skills. But now, a lot of mutual funds invest in a portfolio that is like an index. It lets them get similar returns and lowers their risk. But if they charge you a management fee, this may not be the best way to invest.

    4. Giving short-term growth more importance than long-term growth

    Fund managers may put more emphasis on the fund’s short-term growth to make it look more appealing to individual investors. This lack of long-term thinking could force the fund manager to ignore the bigger picture and focus only on how the next quarter will go. The short-term goals of a fund may affect how you do as an investor and what your financial goals are.

    5. Incentives

    Mutual fund companies need to increase AUM to grow their market share and profits. They often use advertising and marketing methods to get people to invest. It leaves the manager of the fund with little time to run the fund. But none of these things improve how well the fund works. By investing in index funds that are passively managed, small investors can avoid being affected by the fund manager’s goals.

    How to figure out how well a mutual fund did

    Set goals for your investments

    Before you make an investment, you should know what you want to get out of it. Finding the answer to the question is the first step in choosing the best mutual funds.

    Choosing between mutual funds

    The best way to find the best mutual funds is to compare the returns of several similar funds.

    Check out how things worked in the past

    Even though a fund’s past performance doesn’t tell you how it will do in the future, it might be helpful to know how it has done in different market conditions.

    How they did compare to the index

    Even if the fund didn’t do well, management fees still have to be paid. So, before you put money into a fund, compare the fees. Most of the time, better funds will cost you more.

    Risk-adjusted returns

    Mutual funds have to take your capital risk into account. When a fund makes more money than its overall risk, this is called “risk-adjusted returns.”

    Conclusion
    As an investor, you should know how standard fund management works so you can have more control over your money. Start investing in mutual funds with Zebu right away by opening a demat account.