Measuring Strategy Returns After External Cash Flows
Summary
The document considers how to calculate investment performance when capital is added to or withdrawn from an account during the measurement period. A simple comparison of ending balance with starting balance can misstate strategy performance because it counts contributed funds as profit. One answer adjusts the ending balance for contributions and compares it with total capital invested; the example distinguishes strategy gains from a later deposit. Another answer identifies internal rate of return as a possible measure when cash flows occur at different times.
The discussion cautions that internal rate of return may have multiple solutions when cash flows alternate between contributions and withdrawals. It also notes that the time value of money matters and that cash flows need a consistent time basis. The answers are brief and do not provide a full treatment of performance measurement, such as time-weighted returns or the detailed handling of multiple dated flows, so the proposed approaches should not be treated as a complete reporting framework.
Key ideas
- External contributions and withdrawals should be accounted for when measuring strategy performance.
- A deposit increases account value but is not itself a trading profit.
- Internal rate of return can be used to incorporate the timing and size of cash flows.
- Alternating cash flow directions can produce multiple internal rate of return solutions.
- Consistent time units and the time value of money matter when evaluating returns.
Tags
Full text
# Strategy returns when increasing/decreasing a position
# Strategy returns when increasing/decreasing a position
When analyzing the performances of a strategy, the profits are computed as the final balance divided by the starting balance. What happens if the quote quantity has changed in between ?
For example, let's say that I want to trade crypto, on ETH/BTC. I start trading with 1 BTC on January 1st. On February 1st, I have 3 BTC : I realize that my strategy is good (+300%) and I decide to manually buy more BTC. I buy 10 BTC, so now my balance is 13 BTC and I continue to trade.
I could also give the example when the user withdraws BTC from the exchange.
How are the profit/loss updated for an arbitrary number of changes during the period ?
## Answer by Hamish Gibson (score 0)
https://quant.stackexchange.com/a/60890
You would have to take into account the amount you fed in to your system, then compare it to the final amount of your system. In your case, your strategy profited 2 BTC. But you also bought 10BTC with $10X$ units of currency. So your profit should take this into account. Which would be $\frac{13-11}{11} \times 100$
But of course, there is the time value of money to consider, $$e^{-rT}$$.
## Answer by Dave Harris (score 0)
https://quant.stackexchange.com/a/60891
It isn't very clear to me what you are asking, so I am hesitant to answer, but I believe what you are asking for is the internal rate of return. If that is the case, you need to be careful because there can be one root for every change in cash flow direction. So if you are in out in out in out, you will have more than one root.
You do have to standardize the unit of time, so you may also have cash flows with zero dollars.Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.