Risk-adjusted performance ratios in investment strategies

Last Wednesday, around afternoon, I was sitting in a coffee shop and programming a strategy. As I was drinking my coffee, two people next to me were having a chat about Bitcoin and some other cryptocurrencies. One of them told his friend: “I just made the easiest $100 of my life from Bitcoin”. This small piece of story is by no means, a critical approach to cryptocurrencies or that person’s investment view; however, it made me want to ask him: “What is your investment strategy? What return(s) did you get from your trade(s)? What Sharpe ratio do you have?”.

Risk and risk-management occupy a major role in the investment sector, for both buy-side and sell-side institutions. For example in banks, risk departments continuously monitor the risk of their assets and liabilities portfolios. In general, all of their exposures. Without risk there is no reward, and without quantifying risk, investors cannot know if their strategy is good: that “goodness” also seems to be relative.

Imagine two investment strategies containing long-only assets, consisting of stock A and stock B. Hypothetically speaking, both assets A and B are bought on 01/01/2020 and sold exactly a calendar year later, on 01/01/2021, returning 20% of the original investment made. Which investment strategy is better since they both returned 20%? Different…