Choosing Benchmarks for Black-Box Trading Strategies

Summary

The document explains how to choose a representative benchmark when a trading strategy is opaque but has extensive historical data. A clear strategy, such as one holding only long positions in technology stocks, can be compared with a closely related market index. For less obvious strategies, the proposed approach is to infer their broad characteristics from the available trading record, including return profile, typical holding period, long or short exposure, and traded assets.

The benchmark should match those characteristics as closely as possible. If no suitable index exists, the answer suggests building a simple model that captures the strategy’s broad return profile and using it as a custom comparison index. This is practical guidance rather than a tested framework: the document gives no worked example for a complex strategy, quantitative selection criteria, or evidence comparing alternative benchmarks. Benchmark quality therefore depends on how well the chosen proxy represents the strategy’s exposures and behavior.

Key ideas

• Use the strategy’s traded assets and direction of exposure to guide benchmark selection.
• Compare holding period and return profile when choosing a proxy index.
• Build a simple custom index if no existing benchmark fits the strategy’s characteristics.
• Treat the recommendation as a practical framework rather than an empirically validated rule.

Tags

# How to select/construct benchmarks for black-box trading strategies?


# How to select/construct benchmarks for black-box trading strategies?












When faced with a black box trading strategy with extensive historical data available, how would one select/construct a representative benchmark?

As a trivial example, when a strategy historically consists only of long trades on tech stock, the Nasdaq Composite index might be a suitable benchmark.

What about benchmarks for strategies that do not exhibit such clear tendencies in the types of trades they perform?

I can imagine constructing a composite benchmark would be appropriate. Which guidelines/ frameworks/methodologies are applicable?

## Answer by Shane (score 4)

https://quant.stackexchange.com/a/154

Clearly, it's much more difficult than for a white-box strategy.

But you still have some information:

- What is the return profile?

- What is the average holding period?

- Does it go long/short?

- What assets are traded?

Now you can choose a benchmark of an index that matches these criteria as closely as possible. If an appropriate benchmark doesn't exist, then you can create one: produce a very simple model that characterizes the return profile and run it as your own index (just for benchmarking purposes).

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.