If you are new to cryptocurrency or any trading, it’s important you understand what is Return on Investment (ROI) and how to calculate it.
Return on investment (ROI) is a financial metric for measuring the gain or loss, or their respective percentage. It’s always based on the total investment done. Mathematically, it’s the ratio between gain or the loss and the cost involved. Although ROI is a ratio, it is typically expressed as a percentage rather than as a ratio.
ROI in Cryptocurrency
The volatility of cryptocurrency prices makes you earn a positive or negative ROI. If after your investment in the cryptocurrency, its value increases, you move to a positive ROI, else a negative ROI is an undeniable truth.
Suppose, you bought the coin at a price A
On the day of contract or when you liquidated, the price went up to A+10
Volatility or price change equals A+10 minus A, i.e., 10.
Now, the ROI stands at 10 ÷ A × 100
The limitations of ROI
ROI ignores the critical time factor
ROI disregards the time factor. How does it affect the gain or loss? When time factor is not included, one can’t actually tell with a mere percentage that a particular crypto trade was more profitable. Let’s take a look at the price of bitcoin from October 2013 to February 16, 2021.
Let’s take into consideration two ROIs.
CASE#1. Suppose a person invests in bitcoin in March 2020 (BTC equals $6,483.74) and liquidate it in February 2021 (BTC equals $48,125.99)
CASE#2. Suppose a person invests in bitcoin in October 2013 (BTC equals $196.02) and liquidate it in February 2021 (BTC equals $48,125.99)
We have learned volatility or price change is directly proportional to the ROI. It’s evident from the statistical graph that the change was higher in CASE#2 than in CASE#1.
The ROI for CASE#2 is higher than CASE#1. However, the CASE#1 investment is more profitable considering the shorter period, i.e., 1 year. The CASE#2 subject has to wait over 7 years. Thus, ROI doesn’t reflect the profitability or loss in the true sense.
Overcoming the time limitation
The annualized ROI calculation provides a solution by including the time factor, also known as the holding period. The formula for calculating annualized ROI is as follows:
Annualized ROI=[(1+ROI)1/n−1] × 100%
where: n= Number of years for which the investment is held
ROI ignores the risk factor
ROI calculation leaves out the risk factor. While trading a volatile asset like cryptocurrency, risk is a significant factor, which dominates the profitability.
Investors who can assess risks in advance are more successful in cryptocurrency trading. Therefore, you can’t bank on ROI alone while investing.
Overcoming the risk limitation
Use Candlestick chart, and Bollinger Bands to read the risks and appropriately plan your entry and exit strategy. The exercise will help you to reduce loss and make more profit.
ROI ignores the miscellaneous expenses
ROI doesn’t take into account the other expenses involved in crypto trading like transaction fees and withdrawal fees. Thus, ROI value is likely to give you an exaggerated profit or loss or corresponding percentage. The expenses neutralize a considerable part of the ROI.
Overcoming the risk limitation
Bring crypto trading expenses into the calculation. Trade on an exchange that has a minimal transaction fee for spot and futures markets. PCEX Member is one of the leading exchanges that has a flat 0.3% transaction fee for all trading options. It doesn’t have any maker or taker fees as most of the exchanges take.