15
Key Concepts and Definitions of Terms
The disciplines of trading, quality, technology, and new product development each have
their own concepts and vocabularies. In this chapter, we describe key concepts and define
key terms that we will refer to in later chapters. We have placed this chapter up front
because an understanding of the concepts and definitions presented in this chapter is
absolutely essential before proceeding with the rest of the book.2.1. Benchmarking
A benchmark is a standard against which to compare performance. Over the course of
this book, we will use the term benchmark to mean two different but related things:- An index, sector, or peer group benchmark is a reference point against which trading/
investment system ’ s performance measurements can be made. In this respect, we
compare a system ’ s performance to an index like the S & P 500, or industry sector,
or direct competitors. All trading/investment systems must have a benchmark. An
execution benchmark is also a reference point (usually VWAP or an implementation
shortfall, or pretrade) against which trade execution performance measurements can
be made.^1
Sailboat racing is a good analogy. In sailing, speed is proportional to length;
sailboats do not plane for long periods of time. Weight is a second major factor;
light boats plane before heavy boats. As a result, sailboats are handicapped accord-
ing to a formula, which determines the overall speed of a boat given optimal sailing
in a given weather condition.
To make races “ fair, ” organizers group sailboats with similar handicaps into
sections. To win the race, sailors must first win their section. Nonetheless, weather
is a key factor. If the weather favors smaller boats, the winner of the section group-
ing small boats tends to win overall.
The same can be said about trading/investment systems. Market conditions at
any given time may tend to favor one classification or section of trading/investment
systems, for example, small cap funds or large cap funds. The media holds up the
CHAPTER ◆ 2