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Section One: Performance Ratios

A key area of analysis for system traders is evaluating performance using risk based return measures. The performance ratios in the new TradeStation 2000i System Report include:

- Sharpe Ratio

- Return Retracement Ratio

- K-Ratio

- RINA Index

System Analysis Exhibit

SHARPE RATIO

Nobel Laureate William Sharpe introduced the Sharpe Ratio, in 1966, under thename reward-to-variability ratio. This ratio is perhaps the best known of the return to risk measures. The formula for the Sharpe ratio is

SR = (m “ I) / s,

where m is the average monthly return for the period in consideration, I is the risk free rate of return, s is the standard deviation of monthly returns.

Thus, this formula yields a value that could be loosely defined as return per unit risked if we accept the premise that variability is risk. The higher Sharpe ratio the smoother the equity curve on a monthly basis. Having a smooth equity curve is a very important objective for many traders. That is why this ratio is widely used both at an individual market and at a portfolio level. Schwager and other authors have noted that risk might be more accurately defined as downside variability of returns which has led to the introduction of some alternative measures. The Sharpe ratio remains, however, one of the main measures for evaluating the performance of professional portfolio managers.

RETURN RETRACEMENT RATIO

Jack Schwager created the Return Retracement Ratio as another reward to risk measure. A major distinction between this measure and the Sharpe ratio is the use of equity retracement versus variability of returns as a measure of risk. The Return Retracement Ratio places more emphasis on downside volatility. Specifically, this ratio is the average annualized compounded return divided by an average maximum retracement measure. For the detailed calculation of the Return Retracement Ratio see Appendix A.

K - RATIO

Lars Kestner created a ratio that gauges performance by examining the consistency of returns with respect to time. Calculations for return and risk are derived from VAMI (value added monthly index). VAMI is a monthly plot of the progress of a hypothetical $1000 initial investment. For the detailed calculation of K - Ratio see Appendix B. Because the consistency of returns is examined with respect to time, the K “ ratio provides a good evaluation of equity performance.

RINA INDEX

The previous three ratios are equity performance measures. RINA Systems has developed a new ratio, called RINA Index, that is a trade performance measure. The RINA Index is calculated by taking the net profit without trades that are outside of 3 sigma from the average trade weighted by the average drawdown and by the percent time in the market.

RINA Index = (Net Profit “ Net Profit in Outliers)/(Average Drawdown*Percent Time in the Market).

The index is a good substitute for the ratio Net Profit/ Maximum Drawdown. It gives more realistic reward/risk value for a trading performance. In addition to drawdown as an element of risk in the measurement of performance, time-in-themarket is included as another element of risk. The premise is that there is an inherent risk any time a position is established. Following this logic, the RINA Index would be higher (all other variables equal) for a system that spends less time in the market. Generally, a system with a RINA Index of 30 or higher could be considered to have a reasonably good performance.

Using the RINA Index traders get a performance measure independent of the return on equity and initial capital. The RINA Index will not change whether you select fifty thousand or one hundred thousand dollars as your initial capital to trade a strategy. It will, however, change with the price of the underlying moving up or down during the trade. The Sharpe Ratio, for instance, is dependent on the capital in the account upon which monthly returns are calculated. The RINA Index is one of the few ways to measure the quality of the trades themselves, which are generated by a trading system.

Another main difference between the RINA Index and some of the other measures of trading performance is that the RINA defines risk as time in the market and average drawdown. The RINA Index will be biased against a system that has outlier trades. A good example of this is a long-term trend following strategy applied to several markets that attempts to catch the fat tails of price distributions. With the addition of these performance measures to TradeStation 2000i traders have a greatly expanded capability to compare the results of various systems.

For more information about RINA Index please refer to the article Performance Analysis Using RINA Index on RINA Systems web site www.rinasystems.com. The new report also has the ratios like Return on Initial Capital, Annual Rate of Return, Return on Maximum Drawdown and others.