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Selecting a Benchmark - Long/Short Strategies
Charles Lasater
posted Jul 26, 2016
Finance Theory Market Neutral

Still new here, so perhaps a simple question:

When I look at the sample mean reversion strategies that perform both long and short trades I often see that they have no benchmark set or explicitly set SPY.

I would expect a strategy that is both long and short in the same proportion would want to select a risk-free asset as the benchmark. Something like a 1-3 year US Treasury bond ETF, perhaps SHY or TUZ or something else.

Am I missing something? What would you recommend as a benchmark for equal weight long/short algorithms?

Thanks.

4 responses
Nathan Wolfe
Aug 2, 2016

Hi Charles, it's possible to set the benchmark to be any equity you'd like using the set_benchmark function, documented here. I agree that SHY and TUZ could work well as benchmarks for long-short algorithms; you should try them out!

Disclaimer

The material on this website is provided for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation or endorsement for any security or strategy, nor does it constitute an offer to provide investment advisory services by Quantopian. In addition, the material offers no opinion with respect to the suitability of any security or specific investment. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as none of Quantopian nor any of its affiliates is undertaking to provide investment advice, act as an adviser to any plan or entity subject to the Employee Retirement Income Security Act of 1974, as amended, individual retirement account or individual retirement annuity, or give advice in a fiduciary capacity with respect to the materials presented herein. If you are an individual retirement or other investor, contact your financial advisor or other fiduciary unrelated to Quantopian about whether any given investment idea, strategy, product or service described herein may be appropriate for your circumstances. All investments involve risk, including loss of principal. Quantopian makes no guarantees as to the accuracy or completeness of the views expressed in the website. The views are subject to change, and may have become unreliable for various reasons, including changes in market conditions or economic circumstances.

Charles Lasater
Aug 2, 2016

Thanks Nathan. Yeah I'm familiar with how to set the benchmark (sorry if that was unclear). I was focused more on the theory of how to choose which benchmark to use. My understanding is that choosing the wrong benchmark is a common error and could lead to incorrect assessment of the success/failure of a particular algorithm.

Any thoughts/suggestions on resources to consult in the theory or process of selecting the "correct" benchmark for a strategy?

Thanks again!

Max Wilkinson
Aug 2, 2016

Ideally, a benchmark should be neutral - not connected to the investments you are making. However, it should be something that you would invest a whole, or large part of, a portfolio in, so an individual stock is not best suited.

But it is a primarily used as a comparison; so it should fit the risk of the strategy you use. If that is pure arbitrage, the risk does not match with buy and hold - so a T-Bond is more appropriate. It is up to you to decide what risk you are taking and therefore which market gauge to use, but from what I have heard from you the T-Bonds seem to be more appropriate here.

Albert R.
Dec 5, 2019

Very interesting topic (now more than ever).
Is SPY really a good benchmark for the long/short approach? I don't think so.
What is Quantopians recommendation as of 2019?

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The material on this website is provided for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation or endorsement for any security or strategy, nor does it constitute an offer to provide investment advisory services by Quantopian.

In addition, the material offers no opinion with respect to the suitability of any security or specific investment. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as none of Quantopian nor any of its affiliates is undertaking to provide investment advice, act as an adviser to any plan or entity subject to the Employee Retirement Income Security Act of 1974, as amended, individual retirement account or individual retirement annuity, or give advice in a fiduciary capacity with respect to the materials presented herein. If you are an individual retirement or other investor, contact your financial advisor or other fiduciary unrelated to Quantopian about whether any given investment idea, strategy, product or service described herein may be appropriate for your circumstances. All investments involve risk, including loss of principal. Quantopian makes no guarantees as to the accuracy or completeness of the views expressed in the website. The views are subject to change, and may have become unreliable for various reasons, including changes in market conditions or economic circumstances.