ROI is the acronym in English for the term: “Return On Investment,” which means the return on investment. The ROI is a relative value since it always expresses the return or the financial result produced by a particular asset to said investment. Because it is an indicator of relative performance, and it is often described as a percentage.

How to calculate ROI in Trading?

In trading, ROI: is the relationship between money earned or lost and the amount of money that has been allocated to operate.

The following formula is used:

ROI = (Earnings – Trading costs) / Capital used in trading.

This formula expresses the net profit of the trader (earnings-costs) divided by the capital that he has used in his operations. ROI can be calculated over a single period or average across different periods.

As can be seen in the examples, to calculate the ROI, the net economic result of trading is always taken into account, that is, the profit operations recorded in the trader’s history, after all the costs of the trading activity have been discounted, such as spreads, swaps, or interest.

How valuable is ROI in Trading?

ROI is one of the most used indicators to measure the performance of the trading activity. It is usually used in three ways:

  • To define goals.
  • And also To compare operators.
  • To compare trading strategies.

Define Goals

Trading is an activity that combines the use of different analysis techniques with risk management. For trading to be efficient, you have to face the risks assume with the expect return. It is essential to have previously defined profitability objectives.

Before opening an operation. The trader must be very clear about the reasons why he opens said position (analysis) and the capital of his account that he will put at risk in it ( risk  and capital management), as well as the objective profitability of said position (ROI)

The profitability objective will define the trader’s capital at risk in each operation and the number of processes he develops in a period.

This relationship is explain below with an example:

With this target ROI, the trader’s monthly profit would be at least USD 200.

You decide to risk only 1% of your account on each trade as a risk management strategy. In your case, you would bet USD 100 on each transaction.

With this in mind. If you choose to trade that has a risk/reward ratio of 1/1, you should be changing at least two per month to meet your target.

As the risk/reward ratio is 1/1, the expect profit on each trade is precisely equal to the capital put at risk: USD 100. Since the monthly target profit is USD 200. The minimum number of businesses to reach that amount is two.

The example shows that ROI. and trade analysis are closely related to any trading strategy. If the trader opted for businesses with a higher premium instead of trades with a risk/reward of 1/1. The minimum number of transactions would change. Case. What ever the development of the strategy. It would always be precede by the prior definition of an objective ROI.

Compare operators

Comparing the performance of different traders is not always easy since many factors intervene that influence their activity. Such as the size of the account they manage. The period in which the comparison is made, or the risk profile assume.

However, one indicator that is always use when making these types of comparisons is ROI. With similar account and risk management profiles. A trader who obtains a higher ROI in a certain period will have registered more efficient operations in terms of profit than another who has receive a lower ROI…

The comparison can made base on it obtain in a give period or the average ROI calculate from the ROI of each operation of each trader.

Compare Trading Strategies

Another application of ROI as an indicator of profitability is the evaluation of investment strategies when trading. When an operator studies a specific trading strategy. One of the analyzes that he usually performs is to simulate the result that he would have had in the past by applying said strategy.

In this simulation, the trader seeks to calculate the ROI if he has applied the strategy to his trading. It is essential to consider a sufficiently representative period to carry out this calculation. If the analysis period is concise. The simulation may give it values that not representative and may be very high or even too low.

Also Read: How to Trade Stocks- Keys To Successful Stock Trading