adaptation

an evolutionary process whereby a species, or group of market participants, is able to adapt to changes in the market environment.

adaptive markets hypothesis (AMH)

an approach to understanding how markets evolve, how opportunities occur, and how market players succeed or fail based on principles of evolutionary biology.

allocated dollar risk

the amount of dollar risk allocated to a particular futures market.

alpha decay

the speed at which performance degrades as you delay execution.

average holding period

the average amount of time a trade is held.

average PnL ratio

the ratio of wins and losses in the PnL ratio. This is a measure of the magnitude of wins, not simply the rate of wins.

average sector allocations

the average amount of capital allocated to a particular sector.

average trading range (ATR)

an average of the trading range over a given window of time.

average winning trade rate

the average overwinning trade rates.

backwardation

the opposite of contango where the futures price is below the expected spot price. In this situation, hedgers are willing to sell for prices below the expected spot prices.

bond crisis alpha

the return difference between an original return series and the return series with the monthly returns during crisis periods replaced by the risk-free rate. Crisis periods are defined by losses in a fixed income benchmark.

breakout strategy

takes a position when the price breaks out of a range of values, often called the resistance and support levels. A breakout strategy takes a long position when the price goes above the resistance level and a short position when the price goes below the support level.

buy-and-hold strategy

invests and maintains a position over time.

buying-at-the-dips

an investment approach that invests when the strategy is in a drawdown.

Calmar ratio

a comparison of the average annual compounded rate of return and the maximum drawdown risk.

capital allocation

an approach for allocating capital across markets.

channel breakout system

a breakout system that uses channels to determine when signals break out of a range.

coefficient of variation

(for margin to equity) measure of the normalized dispersion of margin to equity.

collateral yield

the return that is earned for collateralized positions via margin accounts.

commodity crisis alpha

the return difference between an original return series and the return series with the monthly returns replaced by the risk-free rate during crisis periods. Crisis periods are defined by losses for a commodity benchmark.

contango

when the futures price is above the expected spot price. In this situation, it is often suggested that hedgers are willing to pay more for something in the future as opposed to what they should expect to pay.

continuous price series

created by removing the gaps in futures price series. The rolling aspect of futures contracts will create gaps in price series requiring adjustments.

contract size

the notional size of one futures contract.

contrarian strategy

trades against the trend and seeks to profit from a price reversal.

convergent

a risk taking approach which is based on a particular view regarding the fair value of an underlying asset.

cost of carry

the costs associated with an investment position. These costs can include financial costs, interest costs, or convenience-related costs for the case of commodities.

counterparty risk

the risk that a counterparty will not fulfill the terms of an agreement.

credit risk

the risk associated with counterparties not being able to repay their obligation or fulfill their side of a contract or position. Credit risk relies on the behavior of individual counterparties.

crisis alpha

performance during periods of market crisis.

crisis alpha opportunities

profits that are gained by exploiting the persistent trends that occur across markets during times of crisis.

crisis beta

an alternative beta related to the traditional beta. The key difference is that crisis beta is constructed to take into account conditional correlation. More negative crisis beta indicates greater diversification benefits.

crisis period

a period of time defined by crisis. Many alternative definitions may be used to define a crisis period. Crisis can be defined by past returns, increases in volatility, or by other measures.

directional strategies

take long or short positions in financial securities in hopes to profit from directional moves. Common examples of these include managed futures (CTAs), equity long bias, equity short bias, and global macro.

discretionary

strategies that use some level of manager discretion.

dislocation

prices move away from no arbitrage relationships.

divergence

the process that market participants and groups of market species evolve and adapt to new market conditions creating trends in prices.

divergent

a risk taking approach which is based on no particular view regarding the fair value of an underlying asset.

divergent trend following index (DI)

a basket of divergent trend following strategies that represent a wide range of loss tolerances.

divergent trend following strategy

a basic trend following strategy that includes a basic entry decision, uses a trailing stop for exit decisions, and employs equal risk allocation across markets.

diversification ratio

a measure of diversification in a portfolio. This ratio is measured by the sum of individual market value-at-risk divided by the total portfolio value-at-risk.

downside risk

measures the variability of underperformance below a minimum target rate. The minimum target rate can be zero, the risk-free rate or any other fixed threshold. All returns above the threshold are included as zero in the calculation of the downside risk.

drawdown

measures the loss from an investor’s peak net asset value (NAV).

drawdown length

the length of time spent in a drawdown.

dynamic leveraging

a situation where the amount of leverage depends on the past profits and losses (PnL) in a portfolio.

entry decision

the decision of when to enter a position.

equal dollar risk allocation (EDR)

a strategy that allocates the same amount of dollar risk to each market. This approach does not consider the correlation between markets. It is similar to the 1/N approach, but at the dollar risk level.

equal risk contribution (ERC)

a strategy that allocates risk based on the risk contribution of each market, taking correlation into account. This approach is similar to risk parity.

equity bias factor

a style factor that is the difference between a portfolio strategy with an explicit equity long bias and a portfolio with explicit equity short bias.

equity crisis alpha

the return difference between an original return series and the return series with the monthly returns during crisis periods replaced by the risk-free rate. Crisis periods are defined according to an equity benchmark.

exit decision

the decision of when to exit a position.

expected drawdown length

the expected length of a typical drawdown.

expected longest drawdown length

the expected value of the maximum length of time spent in a drawdown.

expected maximum drawdown

the expected value of the maximum drawdown for a return series given a specific distribution for the return-generating process.

expected recovery time

an indication of the length of time needed to wait for recovery from a drawdown.

explained volatility

the amount of volatility that can be ascribed to fair value and fundamental models. Explained volatility represents the level of risk that is “knowable” or model-able using fundamental models.

forward contract

an agreement between two counterparties (the buyer and seller) to exchange a certain good or commodity (the underlying) for a determined price (the forward price) agreed on at the beginning of the contract (agreement time) and delivered and settled at maturity (settlement date).

futures contract

a forward-like contract with a value that depends on the future value of a good or commodity (the underlying). Futures contracts are standardized, transferable, and exchange traded. Contracts are traded in standard units where the current contract value is contingent on the future value of the specific underlying.

futures contract dollar risk

the dollar risk for one particular futures contract defined by the dollar risk per contract times the point value (or contract value).

futures curve

a plot of futures prices over time.

futurization

the migration of traditional dealer-based bilateral contracts into multilateral standardized “futures-style” contracts that are centrally cleared and exchange traded.

good volatility

the type of volatility where higher volatility is associated with higher positive skewness.

hedger

a market participant who attempts to take positions counter to protect against adverse price moves.

hedging premium

a premium that is earned for taking the other side of a hedging position. When there is excess demand for hedging, a premium can be earned for taking the other side of the trade.

individual market correlation

correlation with other markets for a specific future market.

individual market volatility

price volatility for an individual futures market.

information ratio

the ratio of the annualized excess return relative to a specific benchmark to the corresponding annualized tracking error. Tracking error is defined as the standard deviation of the excess return relative to a benchmark.

interquartile range (IQR)

the edges of a box plot that represent the 25th and 75th percentiles for a given distribution.

intrastrategy or interstrategy

intrastrategy are differences internal to a strategy and interstrategy are differences between external strategies.

invested capital

the total capital invested in a strategy.

leverage risk

the risks associated with taking exposures based on the use of leverage or on borrowed funds.

limit orders

orders that are filled when the market price hits a specific limit or price. As soon as a limit order has been hit, the order is marked to be executed immediately at the best available price.

liquidity risk

stems from a lack of marketability or that an investment cannot be bought or sold quickly enough to prevent or minimize a loss.

lookahead window

a length of time used to look ahead in an observation period.

lookback window

the length of time used for calculations in signal generation.

loss tolerance

the level of losses a strategy or individual can tolerate.

maintenance margin

the amount of margin required to maintain a futures position. When collateral in a margin account falls below the maintenance margin, a margin call is issued.

margin account

a buffer fund that protects the clearinghouse against fluctuations in prices.

margin call

a call for a market participant to supply additional capital or variation margin to a margin account. If a margin call is not responded to, the futures position will be closed.

margin to equity ratio

a measure of the amount of traded capital that is being held as margin at any particular time divided by the total equity.

mark-to-market

the process of marking the value of positions to settlement prices. This process is done on a daily basis in most futures markets. Accounts are marked to settlement prices and the market is cleared to restart again the following trading day.

market allocation

the process with which capital is allocated across various futures markets.

market capacity weighting (MCW)

an approach where capital is allocated as a function of individual market capacity.

market correlation

the correlation of buy-and-hold returns across individual markets.

market divergence

divergence in market prices. See also divergence.

market divergence index (MDI)

a metric at the portfolio level, which is used as a measure of the market trendiness. It can be measured by the average signal to noise ratio across markets.

market diversification benefit (MDB)

the ratio of average strategy volatility for each individual market divided by portfolio volatility.

market order

an order that is marked to be carried out immediately at the best available price.

market size factor

a style factor that represents the difference between a strategy that allocates more risk to smaller markets minus one that allocates more to only bigger (larger capacity) markets based on market capacity weightings.

market volatility

total market volatility for a buy-and-hold portfolio.

Martingale betting

an explicit type of dynamic leveraging. Martingale betting works in the following way: a long position is increased until the first day of positive PnL. Bets are increased when they are losing (a form of doubling down).

maximum drawdown

represents the biggest loss an investor could have suffered by buying at the highest point and selling at the lowest. This measurement often gauges the worst case scenario for an investor.

mean reversion

the act of reverting to the average. In statistical terms, mean reversion can be measured by negative serial autocorrelation.

momentum

prices moving in one direction continue to do so for some period of time.

momentum seeking

(investment strategies) seek to invest when a strategy starts to perform well and divest when it starts to lose money.

moving average crossover strategy

uses moving averages across different windows coupled with crossover rules to determine when to go long or short.

moving average crossover system

a trading system which is built using moving average crossover strategies.

moving average strategy

uses moving averages across different windows to determine when to go long or short.

negative convexity

a function that has a negative second derivative. In practical terms, events on the extreme have much lower value than a linear extrapolation. Negative convexity is often a situation where the input can be a scalar larger than one times the output.

net convenience yield

a yield included in futures prices (particularly commodities), which account for the net benefits over time based on both storage costs and convenience.

nondirectional strategies

focus on taking relative value positions where the positions are both long and short (often) in the same asset class at the same time. Convertible arbitrage, fixed income arbitrage, merger arbitrage, equity long/short, and several others are often classified as nondirectional strategies.

Omega ratio

a ratio that compares the amount of weighted gains to weighted losses. This ratio does not make any assumptions about the distribution of returns. This allows the ratio to take into account the information in higher moments of return distributions.

percentage of winning markets

the percentage of markets that have winning positions for a trend following program.

portfolio correlation

correlation across a portfolio.

portfolio volatility

the total volatility for a portfolio.

position selectivity

the act of selecting certain positions in favor of others.

positive convexity

a function that has a positive second derivative. In practical terms, events on the extreme have a higher value than a linear extrapolation. Positive convexity is often a situation where the input can be a scalar larger than one times the output.

positive skewness

a situation where the distribution of returns has larger gains and less large losses.

price risk

(often called market risk) the risk that the price of a security or portfolio will move in an unfavorable direction in the future. In practice, price risk is often proxied by volatility.

probability matching

a behavioral heuristic whereby individuals select between two choices at the same frequency as the estimated frequency of occurrence for the two choices.

punctured equilibrium

a theory in evolutionary biology proposing that species exhibit stasis, a situation with minimal evolutionary change, these moments are sometimes hit with significant evolutionary change, which punctures the previous equilibrium. Following these significant events, there are rapid changes that occur in species.

pure trend following system

the most agnostic system that can be constructed. A pure trend following system is a trading system designed with no particular bias in liquidity, risk allocation, or sector.

random entry system

an “agnostic” divergent risk-taking system that enters a long or short position with equal probability and exits from an existing position only when a trailing stop is reached. Such a system does not depend on any entry signal, and provides a unique platform to evaluate the market environment from the aspect of position management of a trend following system. The tightness of the trailing stop is the only parameter to characterize the system.

recovery period

the amount of time it takes to recover from the specific drawdown.

resistance and support levels

defined by many different techniques including past prices, trading range, and other indicators. A breakout position takes a long position when the price goes above the resistance level and a short position when the price goes below the support level.

risk

the chance that things will not turn out as expected.

risk target

(level of leverage use) the total amount of risk allocated to a trend following strategy in aggregate.

risk to uncertainty ratio

a measure of the amount of uncertainty in total risk. The ratio is explained volatility divided by unexplained volatility. When this ratio is low, volatility is governed more by uncertainty than fundamental models.

roll yield

the price difference between the near and far contracts (near minus far) normalized by the number of days between the expiration dates for a pair of contracts.

sector bias

occurs when a particular sector is overweighted relative to other sectors.

sector directional bias

when a trading system is specifically designed to have a slant toward long or short positions in a particular market sector. The most common example is an equity long bias.

sector specific crisis alpha

the return difference between the return series and the return series with the monthly returns replaced by the three-month T-bill rate when the months meet a sector-crisis definition.

Sharpe ratio

a simple measure of risk-adjusted performance. The risk-free rate is subtracted from total return and divided by the associated portfolio volatility.

signal to noise ratio

the ratio between the trend and individual price changes for a specific period.

sizing function

a number between –1 and 1 that indicates the size and direction of a position for a particular market. The sizing function often integrates trend strength into position sizing.

skewness

the level of asymmetry in a distribution. It is the degree to which the distribution is not balanced around the mean.

speculative opportunities

opportunities that occur for speculative capital when there are price discrepancies in supply and demand.

speculative risk premium

a premium that is earned by speculative strategies during moments when supply and demand takes time to correct prices.

speculator

a market participant that attempts to take positions to speculate on the direction of market prices.

Sterling ratio

a performance ratio that measures compounded annual return divided by the maximum loss minus a threshold.

stop loss orders

orders to sell at a prespecified price. A stop loss limit order is a stop loss order that becomes a limit order as soon as a certain limit has been reached.

strategy category

the category in which a strategy can be classified.

strategy correlation

correlation between returns from different strategies on an array of individual markets.

strategy returns

returns from a strategy on an individual market.

strategy volatility

volatility of the returns of a strategy on an individual market.

success rates

the rate of successful trades.

swap futures

(or futurized swaps) new, exchange-traded variants of swap contracts that are meant to mimic swaps.

systematic

means that a manager uses technical signals and a trading system to implement positions in a systematic fashion. Systematic trading systems are fully automated.

tail risk multiplier

the ratio between the probability of returning a value two standard deviations or lower to the probability of the normal distribution returning a value two standard deviations or lower. For a particular returns series, if the probability is 10 times the normal distribution, the tail risk multiplier is 10.

tightness of the trailing stop

defined by the number of rolling standard deviations of daily price change for setting a trailing stop.

time to recovery

(of a drawdown) amount of time a strategy requires to recover from a drawdown.

total adjusted dollar risk

the total amount of risk allocated to a market after adjusting for the dollar risk for contracts in that particular market.

tradability

the ability to capture trends in actual positions.

trading range

an estimate in the range that an individual market trades over in a given day. It is defined as the maximum of the high for a day or the previous closing price minus the minimum of the low for the day or the previous closing price.

trading signal

a signal that defines the position in a particular market long or short. Trading signals may be directly trend signals or they may also be filtered or aggregated versions of trend signals.

trading speed factor

a style factor that is the difference between a portfolio of slower (high loss tolerance) strategies and a portfolio of faster (low loss tolerance) strategies.

trailing stop

a stopping rule that depends on the recent path of the price such that the stop “trails” the price.

trailing stop indicator

an indicator that determines when the position should be exited due to the hitting of a trailing stop level.

trailing stop loss tolerance

the amount of loss tolerated by a divergent risk-taking strategy defined by the tightness of trailing stops.

trend beta

the beta coefficient for the relationship between a trend index and an underlying strategy.

trend following squared

an investment approach where an investor seeks to perform trend following on trend following.

trend following system

a system that takes data inputs, processes the information in these data sequences, and systematizes trading decisions.

trend leakage

the rate at which trends leak out into trend signals. This is typically measured by the difference in percentage of positions that are the same sign as the future trend minus the percentage that are a different sign.

trend signal

a signal generated to measure a trend. Common examples use moving average crossover rules or breakout rules. Trend signals are typically but not necessarily binary.

trend size

the magnitude of a trend measured by total price change.

trend strength

the measured strength of a trend. This is a quantitative measure of the level of conviction of a trend. Trend strength is typically measured at the total signal level by aggregating trend signals across various lookback windows.

uncertainty

the situation where the consequences, extent, or magnitude of circumstances, conditions, or events is unknown.

unexplained volatility

the amount of volatility that is attributed to unexplainable factors.

variance ratio statistic

the ratio between the variance of an n-time unit (n > 1) aggregated change and n times the variance of single-time-unit change. The variance ratio statistic can be used to test for deviations from a random walk.

variation margin

the additional cash added to offset adverse price moves. This is often added as the result of a margin call.

volatility cyclicality

the relative speed of cycles in volatility for a particular trading strategy. This can be measured by examining frequencies in the spectral representation of a time series.

win/loss ratio (of trade PnL)

the ratio of trades that have a winning PnL to the trades that have a losing PnL.

winning ratio

(of trades) the ratio of trades that are winners to the number that are currently losers. This ratio gives some sense of if there are more winners or losers. It does not take into account the size of a win or loss.