Constructing the best trading strategy: a new general framework

A new general framework for constructing the best trading strategy for a given historical indicator is introduced in this paper. We construct the unique trading strategy with the highest expected return. This optimal strategy may be implemented directly, or its expected return may be used as a benchmark to evaluate how far away other proposed strategies for the given indicators are from the optimal. Separately, we also construct the unique trading strategy with the highest information ratio. In the normal case, when the traded security return is near zero, and for reasonable correlations, the performance differences are economically insignificant. However, when the correlation approaches 1, the trading strategy with the highest expected return approaches its maximum information ratio of 1.32, while the trading strategy with the highest information ratio goes to infinity.

Constructing the best trading strategy: a new general framework