Categories

Investing

Tools

  • Economy & Politics
  • Investing
  • Personal Finance
  • Related Posts


    20 Must-’Buy’ Stocks Deliver Big Bucks
    Gold Of Switzerland, Netherlands And Sweden Held By Bank Of Canada – Location Unknown
    This Has Never Happened Before
    SoftBank’s First Sony Smartphone Deal Takes Aim At U.S. Market
    European Investors Cut Stocks, Eyeing Fed Moves, Ukraine Tension
    Stock Futures Up, Indexes On Track For 4th Week Of Gains
    Morgan Stanley Plans Natural Gas Export Plant In New Commodities Foray
    China’s Wanda, Tencent, Baidu To Set Up $814 Million E-commerce Company
    Angry Birds And Closed McDonald’s — 5 Things To Know Today
    Tesla To Build China Charging Network With Unicom
    Google Is Working On Delivery Drones Too
    For SpaceX, The Biggest Challenges Lay Ahead
    Is Burger King’s Move To Canada A Raw Deal For U.S. Taxpayers?
    The Bubble Is In Cash, Not Stocks…
    You Are The ‘Russian Hacker’


    The Right Way to View ‘Annualized Gain’ Claims

    Who wouldn’t like to claim a 423,181 percent return in one day?

    Earlier this year, one of my analysts logged a trade with an annualized gain of 423,181 percent. (That’s not a typo.)

    Of course, he’s no billionaire just because of that trade.

    But his trade raises a question people often have about “annualized gains.”

    I frequently get questions on how people should view annualized returns. They can be badly misused and badly misunderstood. So why would an investor even care about them? I’ll explain below why you should care about them.

    In simplest terms, annualized return calculates what would happen if you repeated a trade’s success over the course of a year. If you close a trade for a 10 percent gain over six months, you have a 20 percent annualized gain. The trading year is made up of two six-month periods. And two times a 10 percent nominal return equals a 20 percent annualized return.

    This math makes sense. It lets us compare the success of various trades over various time frames. For example, if you make 50 percent on a trade in just two months, it’s better than making the same gain in two years.

    But extreme “annualized return” examples can create absurd numbers and expectations.

    Take a trader who buys a stock and sells it the next day for a 1 percent gain. That expert can claim an annualized gain of 252 percent. (The convention is to assume there are 252 trading days each year.)

    And if you factor in the effect of compounding gains, the numbers get even bigger. Compounding returns refers to when one day’s gains are reinvested the next day, increasing the value of each subsequent day’s gain. If you calculate compounding returns, the trader can claim an annualized return of 1,127 percent.

    A similar distortion resulted in my analyst’s eye-popping return: He recently closed a trade for a 114.29 percent gain in 23 days. Accounting for compounding returns, he can legitimately claim a six-figure annualized rate of return.

    I think you can quickly tell this is unrealistic and probably impossible. Annualized gains may look good. But they don’t put any money in your pocket. You can’t buy anything with them.

    Also remember, since you can’t lose more than 100 percent on most investments, a 1 percent loss in a single day comes out to an annualized loss of 92 percent. (If you shave 1 percent off the value of something every day, you’ll never reach zero. You simply end up cutting smaller and smaller pieces off a smaller and smaller pie.)

    Compare that with the annualized gain of 1,127 percent, and you can see how adding up a bunch of annualized gains can quickly distort the truth.

    If that’s the case, why use “annualized gains” at all?

    Because annualized returns are a key tool for comparing the returns of investments with different timeframes.

    Suppose I offer you the choice of two investments.

    Investment A will return 4 percent in three months. Investment B will return 7 percent in five months. It’s clear that Investment B offers a higher return, but it will take longer to get it.

    This is where using annualized gains can help. Investment A has an annualized return of 16.99 percent. Investment B has an annualized return of 17.63 percent. Investment B still offers the better return.

    So what are the rules to annualized gains?

    First, don’t take them as gospel if someone is trying to convince you of an investment or trading strategy. Second, the shorter the time period, the less useful annualized gains get. (Think about the one-day trade example.)

    Again, to calculate your own annualized gains, you just need to do a little bit of simple math. Start with how long the trade will last (or lasted). Then, figure out how many of those time periods fit in a year. Finally, multiply the result by the gains.

    So let’s say you have a trade that will close in three months. There are four three-month periods in a year. If the trade returns 10 percent, your annualized return is 40 percent (four times 10 percent).

    Of course, as the saying goes, you can’t “eat” annualized returns. And you should always be skeptical if an annualized gain sounds outlandish.

    But don’t dismiss them entirely. They’re a handy tool for comparing different trades.

    Here’s to our health, wealth and a great retirement,

    — Dr. David Eifrig

    This article originally ran on Wednesday, Aug. 14, at DailyWealth.com.

    Dr. David Eifrig Jr. is the editor of two of Stansberry's best advisory services. One of his advisories, Retirement Millionaire, is a monthly letter showing readers how to live a millionaire lifestyle on less than you'd imagine possible. He travels around the U.S. looking for bargains, deals and great investment ideas. Already his average reader has saved $2,793 since 2008 (documented in each Retirement Millionaire issue). He also writes Retirement Trader, a bi-monthly advisory that explains simple techniques to make large, but very safe, gains in the stock and bond markets. This is a pure finance play and the reason Porter Stansberry loves having "Doc" on the team. Doc holds an MBA from Kellogg and has worked in arbitrage and trading groups with major Wall Street investment banks (Goldman Sachs). In 1995, he retired from the "Street," went to UNC-Chapel Hill for medical school and became an ophthalmologist. Now, in his latest "retirement," he joined Stansberry & Associates full-time to share with readers his experiences and ideas.

    | All posts from Dr. David Eifrig Jr.

    Discuss this Story:

    Comment Policy: We encourage open discussion. Comments including racist statements, profanity, name calling or spam will be removed at our discretion. We use filters for spam protection. If your comment does not appear it is likely because it violates the policy.

    No Easy Exit From The Euro
    Economics Isn’t Science Or Literature
    GDP ‘Good News’ Sparks Bond Buying & Stock Selling, Treasury Curve Crumbles Further
    The Nail In The Petrodollar Coffin: Gazprom Begins Accepting Payment For Oil In Ruble, Yuan
    “Valuation Is The Market’s Biggest Headwind”
    What The Next Gold Confiscation Will Look Like
    5 Banks Hit By Hackers; Russians Suspected
    Will Fresh Economic Data Back Bullish Thesis?
    Companies Are Cutting Chief Operating Officers
    Alibaba’s Latest Prospectus Carries The Starkest Message Yet For Investors—it’s Not About Your Needs
    Jobless Claims Fall For Second Consecutive Week
    JPMorgan Confirms It Is Investigating Possible Cyber Attack
    Dollar General Says Committed To Family Dollar Deal
    U.S. Futures Fall As Ukraine Fears Return To Forefront
    FBI, Secret Service Investigate Reports Of Cyber Attacks On U.S. Banks
    Bruised Euro Holds Ground Ahead Of Inflation Test
    Judge Rejects Apple Bid For Injunction Against Samsung
    Microsoft CEO Nadella To Visit China Amid Antitrust Probe
    Bitcoin Shows Staying Power As Online Merchants Chase Digital Sparkle
    Tyson Wins U.S. Justice Dept Antitrust Nod For Hillshire Deal
    Mega-IPO To Rekindle The ‘Bromance’ Behind Alibaba’s Rise
    Analysts Turn Mega-Bullish On 13 Stocks
    The Greatest Depression? German Yields Now Negative Through 2017
    More Bad News Out Of Europe Coupled With Hopes For More QE Push Stocks, Bonds Higher
    Currency Wars: Russia Not Declaring All Gold Reserves To IMF?
    Forget Geopolitical De-Escalation; Here’s The Real Reason Why Oil Is Tumbling
    Yesterday’s ‘Market’ “Issues” Were Worse Than The Flash Crash
    China Industrial Commodities Collapse As Sentiment Tumbles To 15-Month Lows
    Treasury Curve Collapse Signals Multiple Expansion Exuberance Is Over
    Apple Moves Upmarket Because It Can
    Read more from Investing...

    Liberty Investor Digest

    Get today's most important
    financial headlines all in
    one place by email!



    Sources


    close[X]

    Sign Up For Liberty Investor Digest™!

    Get Liberty Investor Digest FREE By Email!

    Input your name and email address in the fields below and get today's most important financial headlines sent straight to you inbox!

    Privacy PolicyYou can opt-out at any time. We protect your information like a mother hen. We will not sell or rent your email address to anyone for any reason.