As suggested by Darkhorse, it is important to normalize return for risk. Two traders may create the same amount of wealth, but it is important to know how wild the ride was getting to that point. There are numerous equity-based and trade-based statistics used to evaluate performance. However, in direct answer to the original question that started this thread, % profit is calculated as follows: $ profit / $ equity committed to the trade ($50/$500 = 10%). By including risk factors such as leverage, we would create a statistic other than % profit.
OK, let's do this for real. Since ROI is based on "passive" income (returns on capital usage), and traders have various avenues available to them to "use" (or "abuse") more capital than they have at risk (margin in some cases, prop money in some cases)... All the ROI calculations should be thought of this way..... For example...if my trader "uses" $1 Million of our money to make $5,000 per per week, and yet only has $25,000 at risk...is he making 20% per week ROI? You would think so....but I prefer to think that this person is EARNING money based on his/her Labor, training, time, and abilities....the MONEY is JUST A TOOL.... And a exceptionally valuable tool! For passive "investors" the rules are different. Heck, our "less actively" traded money in our family trusts, etc. may only return 20-30% per year...and we are very happy with that...and yet, if I don't see traders making much more real money (percentage wise), then I think they are "slacking." An objective view of the realities....for your consumption. Don
? Of course returns rise with risk (up to an optimal point). There are many profitable hedge fund strategies that wouldn't even be worth executing without the use of substantial leverage to exploit a marginal but stable edge. Your second sentence is something I already said (or at least I think I did). Re third sentence, people will care very much about the amount of leverage you are using, because the amount of leverage employed translates directly to the bottom line risk you are taking with their funds. Your last statement refers to percentage returns, and again I say, looking at percentage returns alone is grossly inadequate. A bad manager can get high percentage returns with a mediocre strategy simply by taking on massive amounts of unsafe leverage or aggressively exploiting a temporary anomaly. LTCM and Janus are great case studies. p.s. even if you try to deleverage a manager by giving him a smaller portion of your overall capital, that manager will still determine the amount of leverage employed for the capital you gave him. furthermore managers who can achieve the same or higher returns as their peers w / less leverage are generally superior, making leverage a factor in determining quality of performance.
Hmm, the pertinent question then appears to be, how reliable is that risk estimate? When you say the trader is risking 25K to make 5K, are you talking about a loss cutoff point for the week, potential risk based on where stops are placed, or the potential for catastrophic loss in light of a seismic event? Fat tails can be your best friend or your worst enemy... using $1,000,000 in margin yet *only* incurring 25 grand worth of real world risk seems a little off kilter... floor traders get tagged for six figure down days now and then, why would the prop trader profile be so much different?
Maybe, I'd better address that question to Quah, as it seems he had the original question. When he loses a point before he makes the point he then has to make two points in order to recoup his lost point and gain the original 10%, but now he will have to gain over 22%. In the space of a minute the ES contract varies, typically, about 2/3 of a point, so he had better be right on direction (if he is looking to get that point) for a couple of minutes. If he is looking to make two points he had best be right two out of three times (assuming he lost the first point).
We are getting way off topic here. The question was not, what is my risk adjusted return, it was what is my return. We could discuss Sharpe Ratios, Sortino ratios and the likes on another thread if you would like, I do not disagree with you saying that leverage is more or less dangerous. Every investment should be carefully investigated. Unfortunately, even without leverage, the possibility of going broke on a great system is still present.
% return can be unambiguosly calculated only in the context of managing a fund. If one wants to calculate their own % return, then they must first have an initial value for their portfolio. In the simplest example, lets assume that the trader wants to trade 1 contract of ES, he must allow capital that is ideally 3 times his maximum drawdown in backtesting. In order to compare % return between 2 individuals trading the same market, then they must first agree on a common denominator, that is, a "common capital allocated per contract".