3-Year Average Return

The 3-year average return is a financial metric that serves as an indicator of the performance of an investment or portfolio over a three-year period. Specifically, it averages the annual returns generated over this timeline. This calculation is essential for investors looking to evaluate the longer-term stability and viability of an investment strategy, like algorithmic trading (often abbreviated as “algo trading”).

Importance of 3-Year Average Return

  1. Risk Assessment: One of the main advantages of the 3-year average return is its ability to reflect the risk associated with an investment. While short-term returns might be influenced by temporary market conditions, a 3-year period provides a more stable and reliable perspective.

  2. Performance Benchmarking: Investors frequently use the 3-year average return to benchmark performance against other investments or market indices. Consistently outperforming a benchmark over three years can indicate a successful trading strategy.

Calculation of 3-Year Average Return

The formula for calculating the 3-Year Average Return is straightforward:

[ \text{3-Year Average Return} = \left( \frac{\left((1 + R_1) \times (1 + R_2) \times (1 + R_3)\right)^{\frac{1}{3}} - 1}{1} \right) \times 100 ]

Where ( R_1 ), ( R_2 ), and ( R_3 ) are the returns for each of the three years, expressed as decimals.

Example:

[ \text{3-Year Average Return} = \left( \frac{(1.10 \times 1.07 \times 1.12)^{\frac{1}{3}} - 1}{1} \right) \times 100 = \left( \frac{1.33884^{\frac{1}{3}} - 1}{1} \right) \times 100 \approx 9.68\% ]

Application in Algorithmic Trading

Algorithmic trading involves the use of computer algorithms to perform trading decisions based on pre-set rules. The 3-year average return can play a critical role in:

  1. Strategy Evaluation: Algorithms need to be back-tested over extended periods to ensure that they are not simply optimized for short-term performance. The 3-year average return metric helps in evaluating how well a trading algorithm performs over a meaningful period.

  2. Portfolio Management: Investors and fund managers rely on the 3-year average return to manage a diversified portfolio of algorithmic strategies. This helps in understanding the combined performance and risk profile.

Examples of Algorithmic Trading Firms Using 3-Year Average Return Metrics

  1. QuantConnect (https://www.quantconnect.com): QuantConnect offers a platform for designing and testing algorithmic trading strategies. The 3-year average return is one of the performance metrics available for evaluating strategies in their backtesting environment.

  2. Two Sigma (https://www.twosigma.com): Two Sigma is a technology-driven quantitative investment firm that employs algorithmic trading strategies. The firm focuses on using data science and machine learning to generate sustained returns, often measured over multi-year periods including the 3-year average return.

  3. Alpaca (https://alpaca.markets): Alpaca is a commission-free trading platform that offers API access for algorithmic trading. Evaluating the 3-year average return of different algorithmic strategies is crucial for users of the platform to make informed investment decisions.

Conclusion

The 3-year average return is a vital metric for evaluating the long-term performance and stability of investments, particularly in algorithmic trading. It allows investors to gauge the effectiveness of their strategies beyond short-term fluctuations, providing a more comprehensive understanding of potential risks and returns. By integrating this metric into their evaluation processes, traders can make more informed decisions and optimize their algorithmic trading strategies for sustained success.