November 15, 2010 by Andrew 1 Comment

I have talked at some length about historic annualised returns, information ratio, and maximum drawdown %, so it is probably an appropriate time to bring all of these together to show how you can use a combination of these measures to determine if you have an acceptable Portfolio of Trading Strategies.

The basic measure I use is a Raw POTS Score, and I calculate this as:

Information ratio divided by Maximum Drawdown % (where the Maximum Drawdown % is subject to the Maximum Drawdown acceptable by Fund Size  — see table 1, below).

The Portfolio consisting of a single trading Model I introduced in Part 1 of  this series produced an Information Ratio of 0.59, a Maximum drawdown% of 33.36%, which translates into a Raw POTS Score of 1.76.

Adding a second quantitative trading model to the Portfolio in Part 2 of this series resulted in an Information Ratio of 0.80. a Maximum Drawdown % of 32.16%, and a Raw POTS Score of 2.49.

In Part 3, we introduced a third Quant model, which resulted in an Information Ratio for the Portfolio of Trading strategies of 1.50, a Maximum Drawdown % of 28.84%, and a Raw POTS Score of 5.22 (just click on table 2, below, to see the details).

Raw POTS Score for a Portfolio of 3 models

So what is an Acceptable Raw POTS Score, and why the name?

Raw POTS Score

The name comes from the term ‘Portfolio Of Trading Strategies’, or POTS, and the ‘Raw’ bit implies that the scores are further adjusted.

I have previously indicated that I ‘conservatize’ (make more conservative) the historic results derived from backtesting.  I do this in an attempt at recognizing that future performance is rarely as good as past performance in backtested trading models, and to assume that your worst drawdown is yet to come.  My rule for ‘conservatizing’ the raw backtested results is to divide the historic Average Annual Return by 1.5. and multiply the variance of annual returns (variance equals standard deviation squared) and the historic drawdown by 1.5 (see table 4, below).

POTS Score for Portfolio of 3 models

In my Trading Business Plan, I use these conservative results rather than those directly from historic backtests.

The final POTS Score, based on these new conservative numbers, as far lowerd than the Raw Score (as would be expected).  My goal is to trade a Portfolio Of Trading Strategies which give me a POTS Score of around 4.

As you will note from our current POTS scores from the first 3 Quantitaive Trading Models, we’re not there yet!

Let me know if you use any other investment fund performance measures, such as the Sharpe Ratio, the Sterling ratio, the Calmar ratio, or something else.