The 3 Edges of the Sharpe Ratio

There are several ways to measure investment performance.  One such useful measure is the Sharpe ratio, created by Nobel laureate William Sharpe in 1966.  It is widely used because it combines annualized returns with risk into one single number. Why does it matter to combine returns with the risk levels in a single figure? Let me illustrate through a simple

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Annualized Return or CAGR

The Annualized Total Return, also called the Compounded Annual Growth Rate (CAGR), is a useful number to describe the performance of an investment.  Never confuse this with Annual Returns, which is a bunch of numbers that show the returns of an investment for each year during the investment time frame.  Contrary to this, the annualized return is a single number

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Backtesting Strategies & Overfitting

Strategy backtesting is often used to test an investment strategy from historical stock or ETF information (usually price).  The belief is that if a strategy performed well in the past, then it should continue to perform well in the future.

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Annual Returns

Annual returns can be a useful performance measure, but it’s often overemphasized by the investment sales literature.  It’s also sometimes used interchangeably with annualized returns, creating confusion because these are two very different performance measures.  Please see my post on Annualized Returns or CAGR for details on how annualized returns (sometimes referred as CAGR) are calculated. Annual returns generally refer

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Standard Deviation as a Measure of Risk

There are many ways to measure and assess risk in an investment.  The standard deviation is one such way and it measures how much returns change over a period.  This is also known as the volatility of returns.

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Investment Volatility and Beta

The term investment volatility is generally used to refer to how much the price of an asset varies between periods.  The typical period is normally a day, but it can also be weeks (weekly volatility) or months (monthly volatility). There are several ways to measure volatility.  One such way in the case of a stock is to refer to its

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Maximum Drawdown – MDD

Maximum Drawdown (MDD) is a very important measure of investment risk.  It measures the largest percentage drop in the value of a portfolio from a peak to a subsequent bottom before that portfolio value makes a subsequent new high.  Each peak to bottom drop is called a drawdown, and the MDD is the largest drawdown of them all. For example,

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Economic Cycle

In investment-speak, we typically refer to the economic cycle as the time frame that includes a period of expansion followed by a recession.

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