Benchmarking: Compared With What?

[Fairman]

Benchmarking: Compared With What?

A return number means little without a comparison. Choosing the right benchmark for your trading gives context and keeps expectations honest.

Start with cash. A savings account or short-term government bond yields something with almost no risk. If your trading returns less than that after costs, the risk and effort produced nothing.

Next, consider passive investing. A broad index fund has historically delivered returns over long periods with little effort. Compare your annual return and drawdown with it. If your trading earns less than an index fund and takes a lot more time, the comparison matters.

Then consider your risk-adjusted performance. A return of 15 percent with a 10 percent maximum drawdown is better than 20 percent with a 40 percent drawdown. Ratios like return divided by maximum drawdown allow comparison.

For forex, the relevant professional benchmarks are currency hedge funds and managed futures indexes, which provide reference points for what skilled managers achieve, usually single digits to low teens annually, with variable years.

Include your time. Calculate return per hour spent, as a rough measure.

Be careful with short windows. A comparison over three months says almost nothing.

The purpose is not to discourage you, but to keep decisions grounded. If trading serves other goals, such as learning, the benchmark may be different.

Practical step: compute your trailing twelve-month return and maximum drawdown, and compare them with a savings rate and a broad index.

[Fairman]

The savings account comparison is uncomfortable but fair. If a year of screen time beat a fixed deposit by a tiny amount with big drawdowns, that's worth knowing. Do it with the full account balance, not just the profit. If you held 10,000 dollars in a trading account and finished the year 4 percent up after costs, compare that with what the same money would have earned in a dollar savings product or short treasury bills, which some years has been around 4 to 5 percent. In naira, a local fixed deposit rate is the relevant comparison for naira capital. Then add the hours spent, and the comparison gets clearer still.

[Fairman]

Return divided by max drawdown is a simple ratio and easy to calculate from any journal. Good way to compare your year against something passive. If you made 12 percent with a 6 percent max drawdown, the ratio is 2. An index fund that made 15 percent in a year but fell 20 percent at one point has a ratio of 0.75. That doesn't make the trading automatically better, since one year is a small sample, but it puts the result in context. Calculate it each year and track the trend. A falling ratio while returns look stable often means you're taking more risk to get the same result.

[FXS Prop Desk]

A fair comparison also needs to adjust for the risk taken. A trader who earned 15% with a 30% drawdown did not necessarily outperform an index that earned 10% with a 15% drawdown. Comparing return divided by maximum drawdown, or a Sharpe-style ratio, makes the comparison more honest. It also includes the value of time: the hours spent trading have a cost that passive investing doesn't.

[Shadow Trader]

The return over max drawdown ratio has a measurement trap worth flagging. Drawdown measured on end of day balances will look much smaller than drawdown measured on intraday equity, and for anyone holding scalps through news the gap can be large.

Say a year ends up 12 percent. On closing balances the worst drop might be 6 percent, a ratio of 2, while the intraday equity low was 9 percent down, which gives 1.33.

An index fund is usually quoted on daily closes, so comparing it with your intraday figure is slightly unfair to you, and comparing it with your closing figure flatters you. Pick one method and use it on both sides.

The per hour number is the one that tends to end the debate. Take 10,000 dollars up 4 percent, which is 400 dollars, earned over 500 hours of screen time, and that works out to 80 cents an hour against roughly 450 dollars from bills at 4.5 percent with no screen time at all.

That does not mean stop, since the hours might be buying skill that pays later. It does mean the hours belong in the benchmark from the start rather than being added as a footnote.