You might think it’s obvious right? I mean you buy and sell a stock then depending on the return, you can calculate a return. For example:
I buy 100 shares of Microsoft at $26.11 and sell them for $28.25. What is the return?
100 x (28.25-26.11) = $214 profit
Return = Profit / Invested Amount = $214/$2611 = 8.20%
I got an interesting question from a reader that is replicating some of the trades being done here regarding how returns are being calculated.
For long and short trades, that is different. To make my case, I will explain using my 1st trade of the year where I went long Apple (AAPL)and short Blue Nile (NILE). If I am managing a portfolio worth $35,000, and investing 1/7 of that amount in each trade (as per my 2012 trading changes), then I basically have $5000 in each trade.
So on January 5th, I bought Apple (AAPL) and sold Blue Nile (NILE). Keep in mind that there is “no cost” (excluding commissions) to entering into this trade. What do I mean? With $5000, I will be able to
Buy for $7150 worth of Apple (AAPL)
Sell for $7150 worth of Blue Nile (NILE)
That will leave me with the same amount in my account ($5000), an amount that I need to keep as “collateral” for my position. With this amount I am able to:
Buy 17 shares of Apple @ 410.00
Sell 175 shares of Blue Nile @ 40.69
Then, a week or so later, I closed the trade:
Sold 17 shares of Apple @ 419.70
Bought 175 shares of Blue Nile @ 35.47
The profit is:
Blue Nile $914
So on the $5000 that I was using to open this trade, I made a return of 21.6%. As you can see in the “Stock Picks” page, that is how I’ve been calculating returns. The other way would be to calculate the return as follows:
Return = Profit / Bough and Sold amount
In my opinion, that would not be representative however since for a total of $35,000 in the account, I would be buying for $50,000 of shares and selling the same amount.