NEW RATIOS FOR MEASURING OURSELVES

All market men are familiar with acronyms like ROE (Return on equity) or ROCE (return on capital employed) and fundamentally oriented analysts and investors look closely at these two metrics when they pick and hold their stocks. These are decent indicators telling us about the health of the company and the performance of the business. Their own success, for investors, is decided more by how well their portfolio has grown over the years. And the bigger investors or funds or PMS schemes etc. prefer to speak in terms of CAGR (compounded annual growth rate).

But what about traders? Is NP (net profit) their only metric? Most people appear to think so.

Return is usually measured against Time. If investment returns for an asset class is spoken as X% per annum, then what is the benchmark that a trader can look at? Can there really be one?

Often, people use measures like Hit Ratio to define their success in trading or to judge someone else’s. A good hit ratio is an indicator of the methodology that is being used. It gives an idea about the effectiveness with which entry into a trade is made. But the hit ratio is also decided by the exit as the later decides whether the trade ends in a profit or loss. Now, the final outcome may be influenced by several other factors and unless one has looked at all of those factors, a hit ratio cannot really be a good metric. For e.g. an analyst rendering a service can claim to be successful in 80% of the calls given but his subscriber may actually have experienced only 20%- because he didn’t really follow everything that was recommended. A hit ratio could be 60% but still the account may end in a negative- because of a few large blowout losses. The problem for those blowout losses lied elsewhere- not with the method.

I suggest two new acronyms for active traders- ROE (return on effort) and ROTS (return on time spent).

ROE can vary quite greatly. There are traders who just rely on gut feel and therefore there is really no effort made. In contrast there are traders who spend a lot of time networking, being members of multiple WA groups, reading all those messages, having regular conversations with others of the market etc. etc. In other words, make a lot of effort. If both these above people make the same money, is it equitable? Not really.

Then comes the question of how much time you spend trading on a day or week or month.  This too can vary greatly- from the start of the day (preparing for the market day), during the entire day while the market is open, being glued to the screen and then some more chatting with brokers and friends. Such a person spends an average 8-9 hours of his day for about 260 days in a year (number of approximate trading days in a year).

The issue gets worse when someone is a technical analyst. In addition to all the above, he or she will also spend some additional time post market looking at his charts and preparing for the next day or week. If has clients to service, he is probably talking to them late into the night. If he is inclined to make correlation studies, he is probably looking at overseas markets data too. So, in all probability, a committed TA spends close to 10-12 hours every day for 350 days in a year (because he works weekends and holidays too!).

Imagine both these people also trade the market and make some money. Is that equitable between them? No. Can it be equated with the first two guys mentioned earlier? Not at all. For each of them, both ROE (effort) and ROTS (time spent) are substantially different.

Now here is another aspect (and a reason for proposing a new metric). Most trader (unless professional) don’t even have a trading capital assigned! So there is no “return” to be calculated. If they make a lakh, what percentage is it? Cannot answer. Further, they don’t have any ‘portfolio’ to check the value and profits accrued etc.

ROE and ROTS therefore begins to make sense because the only way the trader can measure himself is by comparing himself to a non-market person. Lets say, someone who works at a bank, for e.g. Such a person would be spending a similar 8-9 hours in a day (includes travel and office time). For this, he gets paid a monthly salary. Say, 50K.

Now, any trader should benchmark himself against a person who is similar qualification and economic strata and see what that person shall earn. In the above e.g. we pegged it to 50k salary. Therefore, the minimum that a trader should earn should be a similar 50k. But is that correct? May not really be. For, the trader who makes considerably more effort, the return should be commensurately higher. For the trader who is spending considerably more time, he too should get a return accordingly.

And what about Risk? Traders are taking risks every time they take a trade. So, the compensation has to be higher even! Let’s put a factor of 2 for the risk element (random number) and so the amount now goes up to 100k! The salary comes in every month, on the dot. So, is there some multiple to be applied to certainty as well? Think about that!

Each trader knows how much effort he is making and how much time he spends on his ‘business’ of trading. It is time that they start assigning value to their Efforts and also to the Time Spent if they want to know whether they are really doing well. Any investor knows if his portfolio is growing or not. The market moves and grows his portfolio (mostly). So the E and TS elements are missing for most investors- or can be considered to be quite low. But not for a trader.

Too many people waste their time and let life get away from them because they are not focusing enough on the important aspect marrying time, effort and money. If traders just stick to being ‘largely profitable’ (as many are wont to say), then they are doing themselves a big disservice. Take a longer look at what you are doing and see whether it is worthwhile. If you do it well, trading can be astoundingly worthwhile where the returns are many, many times the ROE and ROTS. That is one of the reasons for being trader, after all! But are you achieving it? If not, maybe you are not being fair to yourself or your family. Think about it. ROE and ROTS. Start measuring them.