by Monty Pelerin
Monty Pelerin’s World
All trading or investing involves risk and return. So do most decisions in life because the future is uncertain and uncertainty is risk. This is the first in likely two or three posts dealing with quantifying risk for the Dynamic Momentum System of trading and its Simple Switching System option.
Relationship Between Risk and Return
People like return and dislike risk. That is just the way we are wired. Risk aversion is universal.
To assume risk, people must expect a return high enough to compensate for that risk. The higher the perceived risk, the higher the expected return must be to compensate. This relationship is the basis for the capital asset pricing model (CAPM) developed by William Sharpe.
Because risk is an important consideration for investors, the Dynamic Momentum System (DMS) and its filter, the Simple Switching System (SSS), are discussed in terms of various measures of risk. This post deals with standard deviation as a measure of risk.