Understanding Risk...

A Sharpe Ratio is (roughly speaking) the excess returns over the observable volatility of an asset. A Sharpe over 1 suggests you get more than compensated for the volatility of an asset. Its important...

In simple terms, Sharpe <1 not great, Sharpe <0.50 a crap shoot, Sharpe > 1 a good risk reward.

For many reasons, it's not a perfect guide but it helps understand if the risk you are taking over time is worth it...

If an asset has 30% annual returns and 30% average 30 day volatility, the Sharpe ratio is very roughly 1. If the returns are less than the vol, it's <1 and above it's >1.

It is a useful guide to finding if you have the right asset for your allocation.

Since the 2019 low, the Sharpe ratio of the Nasdaq is around 1.

The NDX is volatile but you get the turns to compensate for it. That is pretty normal for developed economy equity markets. Returns roughly equal the risk taken.

You need to look for secular trends to do better...

The Sensex in India, low debt, young demographics and accelerated tech adoption is the opposite and the risk is highly compensated. The annual return since 2019 is 40% and the volatility is on average 15%. A stunning approx Sharpe ratio of 2.66!

However in India, around 6% of the returns is explained by interest rates, which lowers the Sharpe a tad but still very good...

In crypto markets:

BTC since 2019 has a Sharpe of 1.24, sort of ok.

ETH has a Sharpe of 1.62, pretty damned good.

But the ETH/BTC cross rate has an even better Sharpe of 1.8%.

That has been one hell of a trade. But, Sharpe ratio's don't remain stable either so its always backwards looking and depends on time horizon.

However...

Risk/Adjusted returns aren't everything either...

If you are reward seeking, not on a risk/adjusted basis, then we get this:

NDX 108%

SENSEX 128%

ETH/BTC 403%

BTC 521%

ETH 1850%

Hmmm.... But you need to see risk too... so maybe current return since 2019 vs max drawdown?

NDX 4.32x

BTC 7.13x

ETH/BTC 7.3x

SENSEX 7.5X

ETH 22x

Ok, its all now confusing. If we use a different time horizon it changes entirely too. Crypto looks worse in 2022 but best in long-haul, so far.

Also, over time, as assets get more mature, their risk/reward goes down as risk is less.

Summing it up, using the brand range of risks, ETH has been the best single major asset to own and SENSEX probably second but that comes with caveats....

Many things will have done better, most worst.

But if you choose an aggressive asset allocation in a particular asset, please make sure you are getting rewarded for it and make sure its trending too (or it's just fleeting returns).

For me, a logarithmic trending chart over several years with high returns, a high Sharpe and high returns vs max drawdown is a decent place to look.

The tricky part is making sure it stays that way. The long-term log trend is what keeps you on track best.

Hope that helps a bit.

Longer-term risk taking (or any risk taking) is not an easy game! People make it sound like it's a science, but it's a art over longer time horizons.

In crypto and tech, network adoption is the KEY driver to add into this mix too.

In other markets, it is often just flows (such as 401k passive flows in US ) or pension finds in EU bonds. But these need to be secular to matter or its a cyclical trade which produces good returns in the cycle but terrible returns in longer term time horizons (commodities).