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

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Ishikawa identifies five steps to making a fishbone diagram:

● Decide the quality characteristic, for example, dispersion of returns or ranges.

● Write the quality characteristic, or result, at the head of the fish.

● Write the main factors that may be causing the dispersion.

● On each cause/branch, write in the details of the causes. On each successive branch,

or twig, write more detail.

● Finally, check that all possible causes are represented on the diagram.

In the end, a fishbone diagram will expose what environmental factors affect the returns,

standard deviations and ranges of returns, and Sharpe and Sortino ratios for a trading/

investment strategy.

29.4. Pareto Analysis

A Pareto bar chart, named after Vilfredo Pareto, plots values in descending order. The

Pareto principle, usually called the 80/20 rule, postulates that 80% of the nonconformances

on a system come from 20% of the causes. On a Pareto chart the left-hand vertical axis

represents frequency of occurrence, the right-hand vertical axis the cumulative percent-

age. This arrangement should highlight the most important among a typically large set of

sources of nonconformance, the highest occurring type of nonconformance.

Pareto analysis is a statistical technique that should identify a limited number of causes

that produce significant nonconformance. The intent is to focus attention on important

courses of corrective action. In essence, the risk manager can estimate the potential benefit

each course of corrective action may yield. Three steps enable Pareto analysis:

● Create a table listing the causes and their frequency as a percentage.

● Create a Pareto chart with causes ranked by importance.

● Draw a line at 80%. This point will separate the important causes from the unimpor-

tant ones.

Result:

Detail

Cause Cause

Cause Cause

Detail

Detail Detail

FIGURE 29-2

29.4. PARETO ANALYSIS