Quality Money Management : Process Engineering and Best Practices for Systematic Trading and Investment

Determine Causes of Variation

Determining causes of special variation, or nonconformance, in a trading/investment system

requires root cause analysis, a set of problem solving techniques that are part of a continu-

ous improvement process. A trading system has two continuing goals: increase returns and

decrease risk (i.e., variation) versus the benchmark. Reducing variation increases a system ’ s

Sharpe ratio and unmasks new sources of alpha. Correcting or fixing a root cause will elimi-

nate the nonconformance and reduce variation. The point is to solve problems by taking cor-

rective action to fix root causes, rather than just treating or masking the obvious symptoms.

CHAPTER ◆ 29

Determine

causes of

variation

Manage portfolio and risk

Plan

performance

and risk

processes

Define

performance

controls

Perform

SPC

(^3) analysis
2
1
FIGURE 29-1
Often there is more than one root cause for a given nonconformance. However, com-
plete prevention of recurrence, called a “ fix, ” by a single inquiry is often not possible.
Like all methods in K|V, root cause analysis should be an iterative, systematic pro cess,
where conclusions are based on facts. Root cause analysis consists of many different
tools and processes, such as the fishbone diagram (a fishbone diagram shows cause and
effect). Nevertheless, for all continuous improvement techniques, a basic outline can be
followed for performing root cause analysis:
● Define the special variation, or nonconformance, using evidence from K|V 4.3.
● Identify issues that potentially contributed to the nonconformance.
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