What is the Sharpe ratio, and what relevance does it have to the punt?
We’ve all heard punters talk about their ‘run of outs’ and after a few in a row pipped at the post they now believe they’re ‘due’.
Every punter has probably felt that way at some stage, but the difference between a professional punter and an amateur is often that they allow for the bad times as well as the good.
A run of outs is only really damaging if you’re betting based on it.
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Here’s a quick look at how you might want to consider setting up your bankroll to make sure you can stay afloat when that string of losers hit.
The Coin Flip Exercise
If you flip a coin, the odds of getting a head or a tail are 50%. Intuitively we think that because there’s 50/50 chance every time we toss a coin in the air, then the string of consecutive heads or tails shouldn’t last long at all.
If you ask an average punter how many times you could flip a head (or tail) in a row, most would answer just a handful of times. However, if you actually sit down and try it, you’d be surprised how often you can get a decent run either way. The same with black or red streaks on the roulette stable – they often last longer than most punters expect.
Those simple examples show us we need to change our thinking when it comes to how we manage our losing runs.
Another common mistake is considering the longest run of outs that’s likely and basing your bankroll on that.
A drawdown can far exceed that any single losing run.
The longest run of outs might be 20, but if that drought-breaking winner was followed by another six losers, then the bankroll may be in real danger.
Risk Adjusted Return
As punters, we’re often drawn to betting because of the perceived returns that are on offer. It’s true that with the right betting approach or service, very big returns are more than possible. Returns that dwarf those of more traditional investments.
But should you be taking more than just the overall return into account? Let’s take a brief look at returns versus the drawdowns
Consider these two examples:
(1) 100% annual return with a maximum drawdown of 65%.
(2) 6% annual return with a maximum drawdown of 2%.
Most would take option (1) in a heartbeat. It’s not even close. Doubling your betting bank each year is an enticing proposition. But another interesting factor to look at is the ratio of return to drawdown.
Option (1) is 100/65 = 1.53. Option (2) 6/2 = 3.0.
What that means is that we are risking far more to achieve higher absolute returns. The ability to double your betting bank each year is enticing. But theoretically, we can use leverage to achieve a superior return with less risk by investing in the more conservative strategy.
The Sharpe Ratio
For investors, one of the key metrics to look for is the Sharpe Ratio and some consider it to be more important than absolute returns.
The Sharpe Ratio measures the annual return divided by the standard deviation of those returns.
Proponents say that earning a consistent return with lower variance is far more appealing than earning a high absolute return with wild swings.
That might stand to reason if you struggle mentally through drawdowns! In a perfect world, we would all like to earn consistent returns without the drawdowns.
A portfolio approach
Really, the key takeaway here for punters is that you should think not just about consecutive losers or even absolute returns, but how you’re managing your overall bankroll. Assessing your own profitability or that of a tipster is more than just winners or losers, but also bankroll management. The Sharpe Ratio – and other related measures – are a decent way to start doing that. If you want more info on it, start here.