Acting in the financial market requires considering a variety of different key metrics. Return on investment (ROI) is one of them. It is widely used when a trader needs to measure the chances of gaining a fast and positive return from the investment. In other words, the metrics make it possible to compare potential profit or loss based on the initial instrument cost.
Another good thing about the metrics is the fact that it can be used either to measure the return in reference to a stand-alone or several investments. Besides, it helps to clarify the attractiveness of various investment alternatives, compare and contrast them, and finally choose the one with higher ROI perspectives. In this article, we will show how to make the necessary calculations and evaluate your possible return.
Explaining the Return on Investment
Before we learn how to calculate the ROI, we need to interpret the term making it easy for traders to understand how it actually works. Let's stress out two major issues of the metrics:
- First of all, ROI is generally expressed as the percentage but not a sum. It makes it easier for investors to understand what to expect in terms of return.
- Secondly, when calculating ROI, you should also consider the net return in the numerator taking into account the return could be either negative or positive.
What Does the Positive and Negative ROI Mean?
A positive figure means when calculating ROI means that the net return is in the black. It means a potential profit, as the total return is very likely to exceed the initial cost of the stock or another trading instrument.
A negative figure means that the net return is in the red. In other words, it can be associated with a potential loss, as the initial cost is higher than the total return.
To make the calculations as accurate as possible, we need to take into account both total costs and returns. This is where a so-called apple-to-apple comparison can work when identifying the best option between two or more competitive investment alternatives.
Methods to Calculate ROI
To calculate ROI, you may opt for two different methods:
ROI Pros and Cons
Now when you know how to calculate your Return on Investment, let's have a closer look at its possible advantages and disadvantages for the trader. On the one hand, the metrics are simple to calculate and consider when choosing an ultimate instrument to trade or invest. On the other hand, it is necessary to consider some other metrics such as timeframes, holding periods, etc.