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Performance attribution

Decomposing a return into its sources: market exposure, sector or factor tilts, timing, selection, and residual. It tells you whether the reason you made money is the reason you thought.

The simplest version regresses strategy returns on a few obvious factors, the market, size, value, momentum, and reads off the coefficients. If 90% of the variance is explained by a beta of 0.9 to the index, then the strategy is a levered index fund with extra steps.

A second cut splits return by bucket: by instrument, by time of day, by holding period, by market regime. Concentration is the thing to look for. If 70% of the profit came from three positions, the strategy has not been tested; three positions have.

Do this on live results as well as backtests. Divergence between the attribution of the two is usually the earliest sign of live-vs-backtest-divergence and is more informative than the headline return gap.

Related: alpha, beta-estimation, information-ratio, live-vs-backtest-divergence

See it drawn

Original diagrams for the ideas on this page. Illustrative, not real market data.

Bearish divergence between price and RSIA price line whose second peak is higher than its first, drawn above an RSI panel whose second peak is lower than its first, with the two peaks joined by sloping dashed lines.PRICEhigher highRSI (14)70overbought30oversoldlower high
Divergence between price and RSI. RSI measures how one-sided recent price moves have been on a 0–100 scale. Here price sets a higher peak while RSI sets a lower one, so the second push carried less momentum than the first.

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