Saturday, April 16, 2011

When Sharpe is useless

During development of an intrady strategy I've come across a case where Sharpe ratio (and Sortino too) is a very bad way to benchmark performance. To illustrate this case, imagine a strategy that enters a position and 'brackets' the exit levels with a limit and a stop-loss order. This results in the pnl distribution as shown in the graph:
The position is either closed at the limit or the stop-loss level, but not in between. Because Sharpe is all about normal distribution, it just does does not work for this case. A better solution here is to use win %, especially in the case of symmetric brackets.