Glossary
ETF
Definition: An ETF, or exchange traded fund, is a basket of investments bought together at once in a trade. It could be a basket of stocks, a basket of bonds, or a combination of stocks and bonds. A popular ETF is SPY, which tracks the performance of S&P 500, which is commonly used to measure the overall performance of the US stock market. By buying SPY, you buy into the 500 largest American companies, all in one trade. ETFs are an effective way to diversify your portfolio, minimize your risk, and pay lower fees than if you had invested in each company individually. ETFs have exploded in popularity in recent years as they are a very cost-effective way to build a diversified portfolio.
Why is it important?
ETFs are the building blocks of a successful portfolio.
Compound Return
Definition: Compound return is how your money grows over time, not just by adding money but also by earning interest or gains on the money you’ve already earned. Over time, this compounding effect can help your investments grow faster.
Why is it important?
Understanding compound return helps you see how even small gains can add up over time, motivating you to start investing early and benefit from compounding.
Annualized Return
Definition: This is the average percentage gain (or loss) you earn on an investment each year. It considers the effect of compounding to give you a better idea of your real investment performance.
Why is it important?
Annualized return helps you compare different investments and understand how much you’re really making (or losing) on your money each year.
Leverage
Definition: Leverage involves borrowing money to invest, potentially magnifying gains or losses. It can increase both potential returns and risks.
Why is it important?
Leverage can boost your profits, but it also heightens losses. Understanding leverage is crucial for responsible investing and managing risk.
Leveraged ETF
Definition: A leveraged exchange-traded fund (ETF) aims to provide returns that are multiples of an underlying index’s returns. For instance, a 2x leveraged ETF tries to give twice the daily return of the index it tracks.
Why is it important?
Leveraged ETFs can magnify gains during periods of market growth. When combined with a successful market timing system, you can potentially capture and amplify the positive trends, leading to even higher returns.
Trend Prophet’s downside protection strategy aims to limit losses during market declines. This can help mitigate the increased risk associated with leveraged ETFs, making your overall investment more resilient.
The combination allows you to harness the potential of leveraged ETFs for higher returns while having a mechanism to reduce risk exposure when market conditions are unfavorable. This can help you manage risk more effectively and should help preserve capital during turbulent times.
Standard Deviation
Definition: Standard deviation is a measure of how much an investment’s returns tend to vary from its average. A higher standard deviation means more fluctuation in returns.
Why is it important?
Standard deviation helps you gauge the risk and potential volatility of an investment. Lower standard deviation often indicates steadier, more predictable returns.
Volatility
Definition: Volatility is how much an investment’s value goes up and down in a short period. Higher volatility means bigger price swings.
Why is it important?
Understanding volatility helps you assess the potential for sudden gains or losses in an investment. It’s important for managing risk and choosing investments that match your risk tolerance. Standard Deviation and volatility are normally used interchangeably.
Risk Tolerance
Definition: Risk tolerance refers to your ability and willingness to handle the ups and downs (volatility) in the value of your investments. It’s about how comfortable you are with the possibility of losing some or all of your money in pursuit of potential gains.
Why is it important?
Understanding your risk tolerance is crucial because it helps you find the right balance between the level of risk you’re willing to take and the potential rewards you seek. It’s like knowing your own comfort zone for taking chances with your money. Matching your investments to your risk tolerance can help you avoid stress and make choices that align with your financial goals and emotions.
Sharpe Ratio
Definition: The Sharpe Ratio measures how well an investment’s returns compensate you for the risk you take. A higher Sharpe Ratio indicates better risk-adjusted returns.
Why is it important?
The Sharpe Ratio helps you compare investments by factoring in both return and risk, guiding you to choose investments that give you a good balance between the two.
Sortino Ratio
Definition: Like the Sharpe Ratio, the Sortino Ratio focuses on downside risk. It considers only the volatility that leads to losses, not total volatility.
Why is it important?
The Sortino Ratio helps you evaluate an investment’s ability to protect you from losses during market downturns, which can be crucial for your overall financial stability.
It is also important to look at this way: No one cares about risk when you make money. Most people are concerned only about losses.
We normally use volatility (or standard deviation) to define risk. However, no one cares about volatility on the upside; you are making money so who cares how wildly prices swing? Since we are more concerned with losses, the Sortino Ratio measures your return per risk taken considering only the volatility of the investment when it loses money.
Up Market Capture Ratio
Definition: This ratio measures how well an investment performs compared to a rising market. It shows the investment’s ability to capture gains when the market is up.
Why is it important?
Up Market Capture Ratio helps you see if an investment can capitalize on positive market trends, potentially boosting your returns during bull markets.
Down Market Capture Ratio
Definition: Similar to the Up Market Capture Ratio, this ratio measures how well an investment holds up during market declines. It shows the investment’s ability to limit losses in a downturn.
Why is it important?
Down Market Capture Ratio helps you assess an investment’s ability to protect your money when the market is falling, which is crucial for risk management.
Maximum Drawdown
Definition: This is the biggest percentage drop an investment has experienced from its peak value to its lowest point.
Why is it important?
Maximum drawdown helps you understand the worst-case scenario for an investment, helping you prepare mentally and financially for potential losses.
Rolling Return Analysis
Definition: Rolling return analysis is a method used to assess an investment’s performance over different periods by looking at average returns. Instead of considering just fixed time frames (like one year), rolling return analysis considers all possible time periods within a given range. It provides a more dynamic view of how an investment performs over time, regardless of when you started investing.
Why is it important?
Rolling return analysis helps you understand an investment’s consistency and its ability to weather various market conditions. It’s like taking a snapshot of an investment’s performance from different starting points, giving you a more comprehensive picture of how it has historically behaved. This can help you make more informed decisions, as you can see how an investment held up over both good and bad times, which is valuable for assessing its long-term potential.
Correlation
Definition: Correlation measures how two investments move in relation to each other. A correlation of +1 means they move in perfect sync, while -1 means they move in opposite directions.
Why is it important?
Correlation helps you diversify your portfolio by investing in assets that don’t move in the same direction, reducing overall risk.