AI For Trading: Why Log Returns? (10)

Let's summarize what we just learned. These are some generally accepted reasons that quantitative analysts use log returns:

  • 1、Log returns can be interpreted as continuously compounded returns.
  • 2、Log returns are time-additive. The multi-period log return is simply the sum of single period log returns.
  • 3、The use of log returns prevents security prices from becoming negative in models of security returns.
  • 4、For many purposes, log returns of a security can be reasonably modeled as distributed according to a normal distribution.
  • 5、When returns and log returns are small (their absolute values are much less than 1), their values are approximately equal.
  • 6、Logarithms can help make an algorithm more numerically stable.

Stepping back, it may not be immediately obvious why all these attributes are benefits. Don't worry about this. As you progress in this course and beyond, you will see more applications of returns and log returns in trading strategies and algorithms and you'll be able to better appreciate why they are used.