Way of the turtle

Measuring Risk versus Reward
There are several unified risk/reward measures that are used com-
monly to compare systems and trading managers who employ sys-
tems for their futures trading funds. The most common of these are
the Sharpe ratio and the MAR ratio.
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Way of the Turtle

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40%
Monthly Returns
30%
20%
10%
0%
–10%
–20%
–30%
Losing Months
Jan
2006
Ju
l 2005
Jan
2005
Jul
2004
Jan 2004
Ju
l 2003
Ja
n 2
003
Jul 2002
Jan
20
02
Ju
l 2001
Jan 2001
Jul 2000
Jan 2000
Jul 1999
Jan 1999
Jul 1998
Jan 1998
Jul 1997
Jan 1997
Jul 1996
Winning Months
Figure 7-5
Donchian Trend Monthly Returns: January 1996 to June 2006
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The Sharpe Ratio
The Sharpe ratio is probably the most common measure used by
pension funds and large investors in comparing potential invest-
ments. The Sharpe ratio was invented by the Nobel laureate
William F. Sharpe in 1966 as a measure for comparing the per-
formance of mutual funds. This measure was introduced as a
reward-to-variability ratio but subsequently came to be referred to
simply as the Sharpe ratio after its originator.
The Sharpe ratio takes the differential return, which is the
CAGR% for the period being measured (i.e., a monthly or yearly
period subtracts what is known as the risk-free rate or the rate of inter-
est one could get by investing in a risk-free bond such as a T-bill) and
then divides it by the standard deviation of the returns being meas-
ured (generally monthly or yearly). Keep in mind that the Sharpe
ratio was conceived as a measure for comparing the performance of
mutual funds, not as a comprehensive risk/reward measure. Mutual
funds are very specific types of investment vehicles that represent an
unleveraged investment in a portfolio of stocks. 
The original role of the Sharpe ratio as a tool for comparing the
performance of mutual funds gives important clues to the types of
risks it does not contemplate. Mutual funds as they existed in 1966,
when the Sharpe ratio first was proposed, were unleveraged invest-
ments in portfolios of U.S. stocks. Thus, a comparison between
mutual funds was one between investments in the same markets
and with the same basic investment style. 
Further, at that time mutual funds held long-term investments
in portfolios of stocks. Not having a significant timing or trading
component, they differed from each other only in their portfolio
selection and diversification strategies. So, for the special case of