In today's advice, we’ll be introducing you to a ratio with a fishy sounding name - the Calmar ratio, which in the opinion of many investors, solves quite complex problems when choosing an investment.
All investments come with a degree of risk and having a way to measure that risk is an important part of making a sound investment decision. This is why many investors find the Calmar ratio so useful.
So what actually is it?
Well, the Calmar ratio is a formula used to measure a hedge fund's (investment program in our case) performance relative to its risk. It's calculated by taking a hedge fund's average annual rate of return, typically over a three-year period, and dividing it by the fund's maximum drawdown capability.
The Calmar ratio is one of the most popular indicators of the effectiveness of an investment program. However, this indicator is inherent in one drawback; namely - there is no time-binding.
For example if the account stagnated for a year with zero profitability, and in the last month the trader accidentally got > on a good wave and earned a lot of profit, then the Calmar ratio can indicate a great manager's performance, although > in reality the strategy is unprofitable.
The formula is based on the so-called compound profit percentage, which is formed over a long period of trading (1-3 years for instance), and the duration of a stable trade is one of the primary indicators of the viability of performance..
This is why we won’t be implementing this ratio right from the get-go. You can still vote, if you want to see this ratio in the future, but the last thing we would want is to add a ratio, that will misinform our investors. Hence, we’ve decided that we might add this lovely little ratio to our platform in a few years when the managers will actually have enough data and trading history for this ratio to work as is intended.
If the ratio appears on our platform - here is a rule of thumb on how to use it: the minimum value of the Calmar ratio must be at least 3, because otherwise the strategy is not viable, meaning the drawdown and risks are much higher than the profit to be sought.
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Thank you for tuning in, and until the next time!