THE SHARPE INVESTOR STRATEGY
This post was written for www.hnworth.com, a site targeting high net worth individuals in Singapore.
Have fun reading !
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Looking back on the past fortnight, I realise that I have been writing on the recurrent theme of volatility and it is not often that I think too hard about my psyche (perhaps for fear of what I will discover ?).
Humour aside, it dawned on me that I have been reacting to an inner instinct that is not unique because conversations with friends in the past week has unveiled a variety of concerns that all converge on the same uncomfortable feeling of a certain anxiety in our selves that we cannot seem to pinpoint to a specific source.
Maybe it is we were all, at some point, traders and carry the same cross of risk management ingrained at the backs of our minds, making the same risk-reward decisions daily as a second instinct.
So what is going on in our heads ?
The volatility.
As I wrote last week, we are seeing inordinately large daily trading ranges in currencies and the second largest stock market in the world, China, Gold and government bonds, unexcepted.
We saw a Crash, Boom and Bang in Shanghai Composite, within the same day, something that has not happened in years.
The market is clearly confused, uncertain and running on the extreme spectrum of Fear and Greed.
In such times, many of us dust off those old financial texts and pull out the chapter on the Sharpe ratio, that we should not expect half the Chinese investors to know about because, like we mentioned before, the literacy rate of the hordes of new investors is falling.
http://www.hnworth.com/2015/04/06/the-monkey-trading-challenge-in-china/
In simple terms, the Sharpe ratio is “a measure that helps investors figure out how much return they’re getting in exchange for the level of risk they’re taking on”. http://www.wsj.com/articles/SB10001424052702304692804577283773166995992
How we do that is to take our returns or expected returns and divide by the standard deviation of market gyrations from historical norms. If the number is high, then the investment is worth keeping and a low number indicates that returns do not compensate for the risk.