I have a few comments and a question. I'll start with the comments.
"My goal is to create an algorithm with a sharpe of at least 2.0 (I have managed to reach 1.6 with an algorithm before) that will trade UPRO or SPXL and SPXU so that it can be run 'long-only' through Robinhood to avoid commissions. I would like to put an initial $40,000 into this algorithm."
I applaud you for having goals. Without goals in life, where would we be? Haha. But I'd like to offer you a perspective you may have never considered before.
Have you ever considered having goals is a counter-productive way to approach your trading? The overarching goal of professional speculation is to create a strategy with a sustainable edge and to manage your risk along the way. When I say “a strategy with a sustainable edge”, you could also think of it as one that has positive expectancy – ie. the combined odds (winning %) and the expected payoff are sustainable into the future and in your favor. Think 50% win rate and getting paid 2-to-1 every time you place a trade. The odds are clearly in your favor so you’d want to play that game over time.
Now why don’t we try to think about it in a similar, but slightly different context from algo design. Take a professional poker player’s perspective. They’re counting cards and keeping track of what the other players are doing. All in an effort to discern what the other players might be holding. Then, based upon that information, they size up their expectancy (odds of winning and expected payoff) and make a bet accordingly. They might think, “well Joe over there checked on fourth street and raised on the flop. I think he’s holding either two pair or he’s working on an outside straight. I’ve got 3 of a kind. Right now, I need to risk $X to potentially get paid out $Y and the odds of me winning are approximately Z%. So yeah, this bet has positive expectancy. I may not win the hand, but if I take this kind of bet over and over again, I’m going to come out ahead in the long run.”
That’s how you should be looking at your algo design. Setting a performance goal like “sharpe ratio of at least 2” introduces unintended consequences and counter-productive thoughts. It’s the equivalent of a professional poker player saying, “Ok… I need to make $1,000 every hour. I gotta do it. It’s my goal” What might happen if he imposed that kind of demand on his decision making? He’d take shots that just weren’t there because of some arbitrary, self-imposed goal. “Well, I’ve only made $300 so far this hour and I’ve got 10 minutes left, I guess I REALLY have to win this hand if I’m going to meet my goal.” But what if he got dealt a mediocre hand? Should he try to meet his goal even when the opportunity isn’t there? That would be what’s going on in his head and it’s the opposite of what he should be doing.
Is it possible your self-imposed goal of “sharpe ratio of at least 2” could cloud your judgement as you’re designing your algorithm? Only you can decide for yourself, but in my experience it’s one of the silent killers of aspiring quants.
Here’s a piece of advice:
Take some time and look into the performance track records for professional money managers. The hedge fund space would be a great place to start. Go look at the firms with the longest track records (20+ years) and examine their sharpe ratios. Are they above 2? Are they even above 1? These are some of the best and the brightest in the world. REAL people who have managed and compounded REAL money over a career. What do their performance track records look like? And what does it make you think about the goals you currently have in place?
And lastly… a question.
“... but have not yet live traded any algorithm so far although the backtests showed potential.”
Why is that? Does the answer start with a “C” by chance? ;)