While Return on Investment (ROI) is a key metric for evaluating the profitability of a trading strategy or investment, it is not the only metric that should be tracked. ROI provides a snapshot of the overall return, but it doesn’t give a full picture of a strategy’s effectiveness, risk, or long-term sustainability. To make informed decisions and ensure consistent performance, you need to track a variety of other metrics, such as drawdown, risk-adjusted returns, and volatility, among others.

Why some believe tracking ROI is enough

1. Simplicity and focus
ROI is simple to calculate and provides an easy-to-understand measure of profit relative to initial investment. It’s a widely recognized metric that is often used to gauge the success of a trading strategy or investment. Traders may believe that ROI alone is sufficient to evaluate performance because it gives them a quick overview of their returns.

2. Emphasis on profitability
Traders and investors typically focus on profits, as this is the ultimate goal of most investment strategies. Since ROI is directly related to profits, some may assume that it is the most important metric and that focusing on ROI ensures long-term success.

3. Lack of awareness of other risks
Many traders, especially beginners, may not fully understand the need for tracking other risk-related metrics such as drawdown, volatility, and risk-adjusted returns. They may feel that as long as they are making profits, other factors are secondary.

Why tracking only ROI is insufficient

1. ROI doesn’t account for risk
One of the main limitations of ROI is that it does not measure the risk taken to achieve those returns. A trader might have a high ROI, but if it was achieved by taking excessive risk, the strategy could be unsustainable in the long term. Risk-adjusted metrics, such as the Sharpe ratio, provide a better understanding of whether the returns justify the level of risk involved.

• Example: A trader could have an ROI of 20% in a year, but if their maximum drawdown was 50%, the strategy is highly risky and might not be sustainable.

2. Lack of insight into volatility
ROI doesn’t account for the volatility of returns. Two strategies could deliver the same ROI, but one might do so with constant fluctuations, while the other might achieve the same return through steady growth. The latter is likely more stable and sustainable in the long run. Tracking metrics like the Sortino ratio (which focuses on downside volatility) or standard deviation helps assess how volatile returns are.

3. Drawdown is crucial for understanding risk
Drawdown is the measure of the peak-to-trough decline in an investment’s value, and it is essential for assessing the worst-case loss a trader might face during a drawdown period. ROI doesn’t tell you how much you could lose before achieving a profit. A large drawdown can significantly affect a trader’s capital, and tracking it helps in understanding potential risk exposure.

4. ROI doesn’t measure consistency
A strategy might show a high ROI, but this doesn’t guarantee that the returns were consistent throughout the year. A consistent strategy is generally preferable to one that provides large returns in short bursts followed by significant losses. Metrics like the Calmar ratio, which relates return to drawdown, can provide a better sense of a strategy’s consistency.

5. ROI doesn’t reflect long-term sustainability
A high ROI in the short term might be appealing, but it doesn’t always indicate that the strategy will work well in the future. A strategy might have achieved a high ROI due to one-off events or specific market conditions, and it may not perform as well in different environments. Tracking multiple metrics over a longer period, such as annualized returns, helps assess whether the strategy can be sustained over time.

What other metrics should be tracked in addition to ROI?

To get a more comprehensive understanding of a trading strategy’s performance, consider tracking the following metrics:

1. Sharpe ratio
The Sharpe ratio measures the risk-adjusted return of an investment by comparing the return of the strategy to its volatility. A higher Sharpe ratio indicates that the strategy is providing more return for each unit of risk. This helps assess how well returns justify the risk taken.

2. Drawdown
As mentioned earlier, drawdown measures the peak-to-trough loss in the value of an investment. It’s essential for understanding the maximum potential loss you could face and evaluating whether you’re comfortable with the level of risk the strategy entails.

3. Sortino ratio
The Sortino ratio is similar to the Sharpe ratio but focuses only on the downside volatility, or the risk of loss, instead of the overall volatility. It’s especially useful for evaluating strategies that have asymmetric return profiles (i.e., strategies that have high upside but limited downside risk).

4. Calmar ratio
The Calmar ratio compares the annual return to the maximum drawdown, providing insight into how much return is achieved relative to the worst drawdown the strategy has experienced. It’s a useful metric for understanding the trade-off between return and risk over time.

5. Win rate and loss rate
Tracking the win rate (the percentage of winning trades) and loss rate helps assess the effectiveness of the strategy. A high win rate doesn’t necessarily guarantee profitability if the average win is smaller than the average loss, which can result in a negative overall return. Tracking both metrics together allows for better risk management.

6. Risk-to-reward ratio
This metric tells you the average amount you stand to gain compared to what you risk on each trade. A higher risk-to-reward ratio indicates that a strategy could be more profitable even with a lower win rate, as long as the average profits on winning trades outweigh the losses on losing trades.

7. Volatility (Standard deviation)
Volatility measures how much the returns fluctuate over time. High volatility can mean that returns are unpredictable, and while it can lead to higher profits, it can also result in significant losses. Lower volatility strategies tend to offer more stability in returns.

Conclusion: Should you only track ROI?

No — tracking ROI alone is insufficient to evaluate the performance of a trading strategy. While ROI gives a snapshot of profitability, it does not provide insights into the risk involved, the consistency of returns, or the sustainability of the strategy. To evaluate a strategy comprehensively, it is important to track other metrics, such as drawdown, risk-adjusted returns (Sharpe ratio), win rate, Sortino ratio, and others. By tracking multiple metrics, traders can gain a better understanding of the true performance and risk profile of their strategy.

Learn how to track important performance metrics, improve your risk management, and develop a consistent trading approach through our expert-led Trading Courses, designed to help you become a more informed and disciplined trader.