Concepts
Reference encyclopedia for quant building blocks: vol targeting, position sizing, overfitting, regime detection, and more.
Risk ratios for backtesting
Alpha (α)
Excess return over a benchmark after accounting for beta; a measure of skill or edge in backtesting.
risk-ratiosbacktestingfactorBeta (β)
Sensitivity of strategy returns to a benchmark; measures systematic (market) risk in backtesting.
risk-ratiosbacktestingfactorCalmar Ratio
Annualized return divided by maximum drawdown; emphasizes drawdown risk in backtesting.
risk-ratiosbacktestingdrawdownInformation Ratio
Active return per unit of tracking error; measures excess performance vs a benchmark in backtesting.
risk-ratiosbacktestingactive-managementMax Drawdown
Largest peak-to-trough decline in cumulative equity; a key risk metric for backtesting and live performance.
risk-ratiosbacktestingdrawdownSharpe Ratio
Return per unit of total risk (volatility); the standard risk-adjusted performance metric for backtesting.
risk-ratiosbacktestingperformanceSortino Ratio
Return per unit of downside volatility; penalizes only bad volatility in backtesting.
risk-ratiosbacktestingdownside-riskVolatility
Standard deviation of returns; the standard measure of dispersion and risk in backtesting.
risk-ratiosbacktestingrisk
Portfolio optimization
Equal Weighted vs Market Cap Weighted
Two common portfolio weighting schemes; equal weight often tilts toward smaller names and can improve diversification.
portfolio-optimizationweightingdiversificationHierarchical Risk Parity (López de Prado)
Portfolio construction that uses a hierarchical clustering of assets to allocate risk more evenly and robustly.
portfolio-optimizationrisk-parityclusteringMPT (Harry Markowitz)
Mean–variance portfolio theory: optimal diversification by balancing expected return and variance.
portfolio-optimizationmean-variancediversificationPosition Sizing
Rules for how much capital to allocate per trade or asset (equal weight, risk parity, Kelly, etc.).
riskportfolio-constructionportfolio-optimization
Other concepts
Correlation Clustering
Grouping assets or signals by correlation structure to manage diversification and risk.
riskdiversificationclusteringDrawdown
The peak-to-trough decline in portfolio value; key risk metric for live and backtest.
riskevaluationmonitoringMean Reversion
The tendency of prices or returns to revert to a long-run average after deviations.
signalsequitystat-arbMomentum
The tendency of assets that have performed well (poorly) to continue performing well (poorly) over the next period.
signalstrendcross-sectionalOverfitting
Fitting a model or strategy so closely to historical data that it fails out-of-sample.
backtestingevaluationmachine-learningPCA (Principal Component Analysis)
Dimensionality reduction by projecting data onto orthogonal directions of maximum variance.
factor-modelsdimensionality-reductionriskRegime Detection
Identifying and adapting to different market states (trending vs mean-reverting, risk-on vs risk-off).
risksignalsadaptationShrinkage
Pulling estimates (e.g. mean, covariance) toward a prior or global average to reduce estimation error.
estimationcovarianceportfolio-constructionTransaction Costs
Slippage, spread, commission, and market impact that reduce strategy returns in practice.
implementationbacktestingliquidityVol Targeting
Scaling portfolio exposure so that realized volatility stays near a target (e.g. 10% annual).
riskposition-sizingleverageWalk-Forward Analysis
Out-of-sample testing by rolling a training window forward and evaluating on the next period repeatedly.
backtestingoverfittingevaluation