The Theory Of Relativity

No! Not THAT theory but the relativity of Return on Investment (ROI).

How does one go about assessing whether a particular strategy is successful? Traditionally, and I include myself in this, one works out a return on investment - a simple calculation where you divide your profit (or loss) over a length of time by the sum total of your liabilities over that time. Seems simple enough, but does it give a true reflection of the success of a strategy?

For example, I'm currently testing a horse laying system which, after 369 bets is showing an ROI of 10%. Not unreasonable I hear you say but, if I express that in terms of the amount of money involved, it is showing a profit of £1471 after 'investing' £14578. It doesn't sound so great.

If I may digress a moment...

I'm from an engineering background and any reader from the same or related discipline will no doubt be aware of the concept of a closed system, a black box if you will. These are used in all forms of engineering and the only requirement of that black box is that, for a given input a known output will be returned. It doesn't matter how that output is obtained - through sophisticated electronics or a group of drunken leprechauns pissing in a bucket - as long as the output is expected and reflects the given input.

From an investment perspective, that closed system could be my stockbroker. If I give him £1K at the start of the year and ask him to come back a year later with my (hopefully) profit, I have no idea, or interest, in the number of times he has recycled individual bets through the markets. As far as I am concerned, my return on investment would be the profit divided by that £1K and NOT the sum total of all the individual investments he has made on behalf.

Applying that ROI methodology to my test strategy and I get a very different figure...

From a standing start, the liability of my first bet was £40. It was a winner and the system has never been in the red so, if I stick the strategy into a black box, I've only ever invested £40 and if I took all the money out right now I calculate an ROI of 3677% !!!

Now THAT is more like it.

So, given that change in perspective, how relative (pun intended) is the use of ROI in assessing the success of a strategy? Perhaps one should not try to complicate matters and simply go by the rule that if, over time, you are in the black, then a success it must be. Whether that success is a decent measure of the amount of time and commitment you have made to carry out the strategy is something only you can answer.

1 comment:

PhilipH said...

Hi Al,
A thought provoking post.
Good to read that you are in credit with your system which is all important of course. A negative ROI is not a lot of good whichever way one calculates it.

If one is SATISFIED with the time one invests in whatever scheme employed AND one enjoys it then OK, but if it computes to an hourly rate of, say, £2, then I can't see the point.

But what do I know? Nuffink really ;-)