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Return on Equity

You’ve been trading for a while and you now have a profit or perish the thought, a loss. What is your return on equity? Determination of return on equity is pretty simple unless you added extra money from a day job or inheritance or you removed money to pay for the kid’s braces or that trip to Tahiti with your significant other.

Let’s determine simple return of equity (ROE%). Assuming no additional funds have been added or withdrawn:

Profit = End Equity or money at the end of the period to be decided minus  Starting Equity or money you started the period.

ROE% = {Profit/Starting Equity} X 100

Simple enough. However this number is more useful if calculated over an annual period. Determine how many days occurred between the beginning of the period to and the end of the period. There are two ways I do this task. Look at the calendar and count. A bit low tech and tedious, but effective. For longer periods of time, I use the Excel Spreadsheet function “Days360” which returns the number of days between dates.

Annual ROE% = { ROE%/number of days} X 365

When you start added or removing extra sums of money out of the trading account calculating a simple ROE will give the wrong answer. This number must be normalized for the period being considered. We do that by adjusting the starting equity.

Equity Correction (EC) = {# of days remaining in period when money is added or subtracted}/total days in period.

For example: If we add money on February 1 and we are calculating the EC for the calendar year, the EC would be 365 – 31(January has 31 days)/365. If we wanted the correction for the quarter, the EC would be {90-31}/90.

Adjusted Starting Equity = Starting Equity + {Additional Money Added X EC} + {Additional Money Withdrawn X EC}

ROE% = Profit/Adjusted Starting Equity

 Example 

 

Date

  Days Remaining
To End of Year
Start 1/1/2002 $50,000  
Add 4/1/2002  10,000 245
  9/1/2002   8,000 92
Withdraw 6/15/2002   6,000 199
  11/15/2002   3,000 46
End 12/31/2002  72,000  

Profit = 72,000 – 50,000 – (10,000-8,000) + 6,000 + 3000
=13,000

Adjusted Starting Equity =
$50,000 + ($10,000 X 245/365) + ($8,000 X 92/365)
-($6,000 X 199/365) – ($3,000 X 46/365)
= $55,079

Performance = 13,000/55,079
=.23 or 23%
 

 

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