Geometric mean return

Understanding Geometric Mean Return

In the world of trading, the term 'Geometric Mean Return' is commonplace. However, beginners might find it hard to grasp. The Geometric mean return is a critical concept in investment analysis. It's used to calculate the average rate of return on an investment, taking into account the effects of compounding over a certain period.

Breaking Down Geometric Mean Return

The Geometric mean return is the average rate of return of an investment, calculated geometrically. This differs from the simple arithmetic mean because it takes into account the order of returns and the effects of compounding. In trading, this latter feature makes geometric mean return a very useful tool for assessing long-term returns.

Importance of Geometric Mean Return in Trading

The Geometric mean return provides traders insight into the real return on an investment. As it takes the compounding effect into mind, it's particularly important for investments where compounding is key. This could include stock, bond or mutual fund investments. It gives you the return rate that, if gained consistently over the investment period, would have resulted in the current value of the investment. It lays the groundwork for accurate projections and profitable trading.

How to Calculate Geometric Mean Return

Here's a simple breakdown to calculate the geometric mean return: Subtract '1' from each investment's return rate, multiply the results together, take the 'Nth' root (where 'N' is the number of investment periods), and finally subtract '1'. You're left with a number that presents the geometric mean as a percentage. This gives traders an accurate picture of their investment’s performance over a period.