Using Rolling Sharpe Ratios to Monitor Strategy Decay
Summary
This article explains how to use an annualised rolling Sharpe ratio to monitor whether a trading strategy’s risk-adjusted performance is weakening. It calculates the ratio from excess returns over a trailing year of observations, scaling the mean-to-volatility ratio by the square root of the annual number of trading periods. The measure can be compared with a benchmark and plotted alongside an equity curve; the article describes its implementation in QSTrader’s performance statistics.
Examples from an aluminum smelting cointegration strategy and a defense-stock sentiment strategy illustrate how the rolling measure can change as strong returns leave the lookback window or later gains accumulate. The first example’s decline is presented as a reason to review whether the strategy’s edge or underlying relationship has changed. The article cautions that Sharpe is backward-looking, captures only volatility relative to excess return, and cannot anticipate events such as regulatory changes or infrastructure failures. It also penalizes upside volatility and should inform, rather than determine, retirement decisions.
Key ideas
- A rolling Sharpe ratio summarizes recent excess return relative to return volatility over a fixed lookback window.
- Annualisation scales the ratio by the square root of the number of trading periods per year.
- Wait until a full lookback window is available before interpreting the rolling estimate.
- A deteriorating ratio can prompt a review of strategy decay, but it does not establish its cause.
- Sharpe is a limited, backward-looking risk measure and cannot capture every source of future risk.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.