Dealing in Alternative Investments requires a bit of statistical knowledge (the more the better). So I picked out one component that would benefit someone who handles their investments personally and, at the same time, benefit someone who pays an advisor because it never hurts to ask the right questions.
The following is not investment advice, but one way to assess the advice you were given…
High Frequency Trading or Unconventional Return Periods
When returns are realized at higher frequencies (many times per year), Sharpe Ratios and the corresponding t-statistics can be calculated in a straightforward way.
Assuming there are N return occurrences per year, and the mean (μ) and standard deviation (σ) of the returns are μ and σ, the annualized Sharpe Ratio can be calculated as (μ×N)/(σ×√N) …or (μ/σ)×√N.
The corresponding t-statistic is (μ/σ)×√(N × number of years).
For monthly returns, the annualized Sharpe Ratio and the corresponding t-statistic are (μ/σ)×√12 and (μ/σ)×√(12 × number of years), respectively. Here, μ and σ are the monthly mean and standard deviation of returns.
Similarly, assuming μ and σ are the daily mean and standard deviation for returns (you traded every day the market was open…please don’t do that:) and there are 252 trading days in a year, the annualized Sharpe Ratio is (μ/σ)×√252 …the corresponding t-stat is (μ/σ)×√(252 × number of years).
The calculators I use to find these metrics are listed in the right-hand column on “my trading desk.” They both have statistical functions.
The Test Statistic
Test Statistics (t-stat,t-statistic) are tricky creatures. Essentially when evaluating performance, I require a t-stat of at least a 4 before considering a stake. In the future, I will explain a simple model I use to allocate cash among accounts and strategies according to their t-stat.
Test statistic= (μ/σ)×√(N return occurrences × number of years).
Note that “N return occurrences × number of years” is just the annual number of return occurrences resulting from the investment or strategy, multiplied by the number of years you pursued that strategy. So, if you closed out 3 trades in a year (at 1%, -2.3% and 3%), that counts as N=3.
Or, if an investment reconciled every 6 weeks, for the past 1.5 years, then N=8.66, ([52 weeks / 6] = 8.66)….now multiply 8.66 by 1.5 years. Square-root all that down to: 3.60
Remember, it is important to convert your daily/weekly/monthly returns to an annual (yearly) number. This makes it very easy to compare performance against conventional, low-return investments pushed by financial salesmen.
And since the volatility adjustment is built-in, it is an apples-to-apples comparison.