Let's say I go long one security, short another. I go long security A at $10. 3 years later its price is $20. I got short security B at $20. 3 years later its price is $15. How would you calculate IRR (or whatever alternative metrics you want) on those positions combined? Would it be a net cash INFLOW on day 1 of $10, because you sold B for $20, getting the cash, and using $10 of that to Buy A, then a cash INFLOW 3 years later of $5 when you close the positions, getting $20 on the sale of A but then having to pay B $15? Is that right? Isn't that like an infinite IRR or something crazy with just net cash inflows and no net cash outflows? Did I just figure out how to make money out of nothing??? Wholly FUK if that is correct... am I thinking about that right?
You can’t spend IRR’s, so you can’t make money out of nothing. Read about IRR to understand it’s shortfalls. There are other return calculations that might be more appropriate and you can derive your own based on your specific needs. I use one type to calculate one strategy. Another to cralculate another strategy to understand relative performance. in the end all that matters is equity at the end vs equity at the beginning.
Thanks newwurldmn. So they how would you calculate your return on investment in my example? Not just how much you made (that would obviously be $15), but how much you made vis-a-vis your investment, as a percentage return.
I was a finance major and graduated with a 4.0 in 3 years. Few in the world probably understand IRR as good as I do. But I'm asking how to calculate it (or other appropriate return on investment parameters) with mixed positions including shorts. But thank you for your snide comment.
Presuming equal external risk with both instruments this will do the job ... https://irrcalculator.net/
One way to look at it is what you got out vs. what you put in. In your case you're left with $40 on a $25 outlay (it doesn't matter how it was done, long/short). This gives you a 60% return (40/25 - 1) over 3 years or a compounded annual return of 17.0%.