289 · Alfonso Peccatiello (MacroAlf) - Beyond Being Right - A Shift to Framework Thinking
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High Sharpe Ratio Signals Risk
Monitoring the Sharpe ratio of crowded carry trades provides crucial insights into market risk. A Sharpe ratio exceeding 1 to 1.5 indicates robust risk-adjusted returns, attracting more investors. However, such high ratios signal overcrowding in trades, particularly evident when the ratio reached 1.45 shortly before the Japanese carry trade crisis. This highlights the importance of recognizing the potential for sudden market reversals as crowded trades can lead to significant volatility triggered by minor events, emphasizing the need for careful risk assessment in trading strategies.
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