Rajat Jain has this interesting question:
Sir, I am a bit confused with regards to calculate the return on my trading, I will explain how and will be very helpful if you can guide me on the same or ask your blog readers to share theirs also.
I bought Yes Bank Futures at around 245 and sold around 255 making a handful 4% in price terms but when I am calculating the same as return on Investment I am getting 11.90% why because to buy a lot of Yes Bank I gave a margin of Rs 42000/- so a lot made Rs 5000/- as such the return is 11.90%, but the risk involved was to the tune of Rs 122500/- (500(one lot)*245(price)), as such when calculated like this the return is 4.08%, so which is the correct method, had the price of Yes Bank became zero this morning I would have been liable to pay Rs 122500/-. though that would have required India to collapse totally this morning but the point is Risk was there as such my notional Investment was 122500/-, but actually I invested Rs 42000/- so return should be calculated on this basis, this is creating a bit of confusion, Can you please guide in this behalf.
When we trade on Margin, our capital investment is the margin required plus an amount reserved to meet any drawdown. The drawdown is never known for sure, we only have to make an estimate of possible losses. A simple rule of thumb is to take a drawdown of Three times the Average True Range. For Yes Bank, ATR on the daily futures chart is 27. Three times 27 is 81.
Our Investment is: Margin + (3 * ATR * Lot Size) = 42000 + (3 * 27 * 500) = 42000 + 41000 –= 81,000
Remember, our largest drawdown is in front of us, not behind us. So, we should be prepared for any eventuality, maintain a safety net in our capital.