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Saturday, November 24, 2012

Measuring Portfolio's Performance

When browsing on the Internet for trading related content, we often stumble upon many websites that reflect some sort of historical performance, usually on a monthly basis. Sometimes we see impressive numbers that just look too good and we start doing the math in our head, calculating how much longer until we get rich with the returns achieved by those guys.

Then you become a subscriber, spend your money and realize that the way they reflected their performance was not accurate, that in fact the way they report performance is the one that makes them look as good as possible. Most websites out there use ROI (Return on Investment) or ROR (Return on Risk), others use "Aggregate Returns", and you, as an investor/trader have to be aware of what all that is and detect the smoke and mirrors by a mile. Ideally you want to see Portfolio Growth, but Portfolio Growth is not the most attractive impressive stat to show so, you may not find it.


With ROI and ROR, the newsletters vendors let you know that they have made a 20% ROI for the month. Did their portfolio grow 20% in a month? Of course not. It means that on the capital invested or risked, the gain was 20%. If the newsletter risked 10% of the portfolio, then the 20% ROI translates to 2% Portfolio Growth. With ROI and ROR you will never be able to figure out Portfolio Growth unless the 'guru' discloses his typical position size per trade. A year of 2000% ROI, can simply be 20% Portfolio Growth for a trader that typically risked or invested 1% of the account per position. See the difference?

Let's say the size of their portfolio at the beginning of the month was $10,000 and the guru had a 10% winning play by using $1000. The return on that particular trade was $100, which effectively represents a 10% return for that particular trade. But when you analyze the portfolio growth, a $100 increase on a $10,000 portfolio represents a 1% growth for the portfolio. In order to make things absolutely clear and transparent, this is the performance that should be reported for the world to see. Of course most won't do it, because reporting a +1% on a given month won't be attractive for most potential subscribers that are seeing higher returns on other sites that are reporting ROI.

What about Aggregated Returns?

Aggregated returns is when they accumulate the ROI of multiple trades in a single arithmetic sum as if all the positions had the same weight. This one is even more deceiving. Let's say you play one trade with $1000. The trade is a winner that returns 10%. You invested $1000 and you left the position when your capital was $1100. A 10% winner.

Then they make a second trade that month which turns out to be a 5% winner. They will report their performance as 15% that month because of the 10% earlier winner plus this second trade that returned 5%. They are "aggregating" their ROIs. But again, did they really grow their portfolio by 15%? No. Far from it. In fact the 5% winner could have been on a $1000 position ($50 profit) and the 10% winner could have been on a $200 position ($20 profit). Total profit for the month in this hypothetical case is $70, which represents +0.7% on a $10,000 account. Nothing to do at all with 15%.

It is incorrect to report the return on a particular trade as the return on your entire portfolio and it is dishonest to report the sum of individual ROIs as the portfolio's performance for any given period.

By the same token, they could win 25 trades during the year, all of them returning 10% ROI, and they will report a 250% performance for the year. Which is totally inaccurate, but makes them look good.

You need to be aware of that and understand all these tricks. Ultimately you want to see portfolio growth. Plain and simple. You want to see clarity, not clouds and confusion so you don't buy into a service expecting those spectacular, unrealistic returns which you will never see as portfolio growth.

The most transparent way to report performance is simply analyzing how much the overall portfolio grew on a given time. If my portfolio was $10,000 on January first and $14,000 at the end of the year, I won $4,000 dollars and that represents 40% of my initial portfolio size. My performance was +40% for the year. Cristal clear, no complications, no tricking of people out there, no false expectations.

So, my suggestion is, don't believe blindly in returns posted out there. Always try to figure out whether Portfolio growth is being reported or Aggregate returns. If it looks too good to be true, it is probably Aggregate returns and ROIs all over the place, which doesn't reflect real equity growth.

For some information on how realistic portfolio returns look, read my previous article Trading with Realistic expectations.

Happy trading!

Related Articles:
Trading with realistic expectations
How much capital do you need to trade for a living

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  1. I know of a French guy who sells trading eBooks and tells people every month that his trading account has grown by +6/8%. Impressive regularity, so much that I suspect that he's found a way to remove randomness from the markets.

    You know what his strategy is? He sells eBooks and adds that extra money to his trading account. Not bad, huh? :P

  2. Hahaha good one! consistent 6 - 8% is impossible