Problem when calculating the daily return on a forex trade, what is the best way to do such a calculation?

Question

I intend to calculate the daily return on my investment in forex. Assume a trader invests $\$$40 at a leverage of 100:1, so in total he is trading $\$$4000 worth of currency, and assume the position is open from Dec 4 to Dec 6. Also the trader has enough money to cover potential drawdowns.

In order to calculate the daily returns I would first need to virtually close and re-open the position using market prices (not shown here) and "realise" the daily profits/losses. Since in forex accounts a position can have a negative profit (as long as you have enough money in the account to cover the cost), this poses a problem when the trade balance is really close to zero and when the trader realises a big gain or loss the next day. To illustrate, I present a real life example below.

Date     PnL       BeginBalance   EndBalance    Return
Dec4     -30       40             10            -75%
Dec5     -10.01    10             -0.01         -100.1%
Dec6     -9        -0.01          -9.01         900,000% 

where PnL is the daily profit or loss calculated using market data (i.e. its the unrealised PnL the trader would see at the end of a trading day), BeginBalance is initially set at 40 which is the amount initially invested, EndBalance is BeginBalance + PnL, and Return is PnL/BeginBalance.

Notice how on Dec 6, the return is 900,000%. While it is an arithmetically correct calculation, this greatly skews my data and is wrong because the balance has dropped from -0.01 to -9.01 which is not a positive return. What can I do to overcome this?

Thanks!

Answer 1

Use your total wealth allocated to the trades as denominator. Total wealth allocated would include all collateral. In this way you (or your broker) make sure that the denominator is always positive. Presumably this would also reflect what you really want to track. The only problem that remains is what amount of your wealth needs to be allocated. But this is something you probably have decided anyway before you started trading.

Answer 2

My suggestion would be to use the actual (leveraged) position value, rather than the cost you paid to open the position. Then if you want, you can multiply the return on the position by your leverage, so you might see something like this (if I understood your question correctly):

Date    PnL      Begin      End     Return
4-Dec   -30      4000       3970    -75%
5-Dec   -10.01   3970       3959.99 -25%
6-Dec   -9       3959.99    3950.99 -23%

Having said that, hopefully you won't need this too much: you normally don't want to let your positions lose more than you had put into them!

Anyway, I hope this works for you. Good luck!