Return on Capital, also known as ROC, is calculated by taking the max potential profit (for a short position) and dividing it by the total amount of capital used. ROC is useful as it shows us how leverage enhances our returns. Return on Capital varies by account type due to differing capital requirements for cash accounts, margin accounts, portfolio margin accounts and IRA accounts. ROC in an IRA account is generally lower because of the lack of leverage.
As a metric, ROC is useful in that it allows us to equate trades into a “single currency”. Showing how leverage is being used to enhance and maximize returns, e.g. pay 0.5% per month to make 0.5% per day, allows for the most efficient use of capital.
When we’re trading, our goal is to place many high probability trades, while using our available capital as efficiently as possible. Understanding the relationship between probability of profit (POP) and return on capital (ROC) allows us to do this. Our ability to pick the probability and returns that fit our portfolio and strategy is one of our advantages when trading a small retail account.
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