How punters can use the Sharpe Ratio

The Sharpe Ratio is a new concept to many punters, but it's well worth considering when assessing various strategies.

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A Run of Outs or Bad Bankroll Management?

If you’ve spent any time at a race track you’ve probably heard a few punters talk about “their run of outs.” They’ve had a few in a row that have been pipped at the post and now they believe they’re “definitely due”. Every punter has probably felt that way at some stage, however the difference between a professional and an amateur is 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.

For example, if you’re betting on horses that have average odds of around $5 and think that the most consecutive losers you’re likely to be faced with is 5 or 6, then you need to reassess your betting and bankroll strategy.

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 as the bankroll you need to be safe. But the drawdown can far exceed that losing run.

For example the longest run of outs might be 20, but if that solitary winner was followed by another 6 losers then a lot of amateur punters would be wiped out.

Risk Adjusted Return

Most punters and followers of betting strategies are drawn to punting because of the perceived returns that are on offer. Many tipsters aim for a 100% return on investment over the course of a betting season or a year.

However is there more to that metric than meets the eye.
Most punters scoff at the idea of having their money invested in the stock market. They see returns of 8-10% per year as something they should be getting every month.

Consider these two examples:
(1) You can earn 100% per year with a maximum drawdown of 65%.
Or 
(2) You can earn 6% per year with a maximum drawdown of 2%.

For most readers of this post, I’d suggest that they’d take the first option in a heartbeat. Doubling your betting bank each year is an enticing proposition – but is it the best one?

A 100% return with a 65% drawdown is what you might get from a number of tipsters and betting services. Whereas a 6% return with a 2% drawdown is more in-line with a diversified bond portfolio, or something that you might want if you’re getting set for retirement.

But what I think is more important is the ratio of Return to Drawdown.

For our betting system, we are getting 100/65 = 1.53.
For our boring bond investment, we are getting 6/2 = 3.0.

What that means is that we are risking far more to achieve those higher absolute returns. While the ability to double your betting bank each year is enticing, theoretically we can use leverage to achieve a superior return with less risk by investing in our bond strategy.

Sharpe Ratio

For investors, one of the key metrics to look for is the Sharpe Ratio. It often carries far more weight than absolute returns.

The Sharpe Ratio effectively measures the annual return divided by the standard deviation of those returns.

What that means is that earning a consistent return with lower variance is far more appealing than earning a high absolute return with wild swings. And that stands to reason. If you’ve had to live through a large drawdown, it can be extremely tough mentally.

In a perfect world, we would all like to earn consistent returns without the drawdowns.

A Portfolio Approach

The takeaway here for punters is that you need to think about more than just your 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.

I find it’s always far more important to look at the ratio of annual return to max drawdown, to get an idea of just how effective my system of a new tipster might be, rather than just looking at winning strike-rate, profit on turnover or how many units a tipster made last year.