# Calmar ratio: Explained | TIOmarkets

BY TIO Staff

|June 27, 2024The Calmar ratio, also known as the Calmar Measure, is a comparison of the average annual compounded rate of return and the maximum drawdown risk of commodity trading advisors and hedge funds. The lower the Calmar ratio, the worse the investment. Named after California Managed Accounts Reports, this ratio is a risk-adjusted performance measure that was introduced by Terry W. Young in 1991.

It's a crucial tool in the world of trading, helping investors to make informed decisions by providing a clear picture of potential risk versus reward. Understanding the Calmar ratio is essential for anyone involved in trading, whether you're a seasoned professional or a beginner looking to dip your toes into the market.

## Understanding the Calmar Ratio

The Calmar ratio is calculated by dividing the average annual compounded rate of return by the maximum drawdown, or the largest single drop from peak to bottom in the value of a portfolio, over a certain period. This ratio is usually calculated over a period of 36 months, but can be adjusted according to the needs of the investor.

It's important to note that the Calmar ratio only considers the magnitude of the maximum drawdown, not its duration. This means that an investment with a high maximum drawdown but a short recovery period could still have a high Calmar ratio. This is one of the reasons why the Calmar ratio is often used in conjunction with other risk-adjusted performance measures.

### Calculating the Calmar Ratio

To calculate the Calmar ratio, you first need to calculate the average annual compounded rate of return. This is done by dividing the final value of the investment by the initial value, raising the result to the power of one divided by the number of years, and then subtracting one. The result is then multiplied by 100 to convert it into a percentage.

Next, you need to calculate the maximum drawdown. This is done by identifying the highest peak and the lowest trough of the investment value over the period, and then dividing the difference by the highest peak. The result is then multiplied by 100 to convert it into a percentage. The Calmar ratio is then calculated by dividing the average annual compounded rate of return by the maximum drawdown.

## Interpreting the Calmar Ratio

The Calmar ratio is a measure of risk-adjusted performance, meaning it takes into account both the potential returns and the potential risks of an investment. A higher Calmar ratio indicates a better risk-adjusted performance, while a lower Calmar ratio indicates a worse risk-adjusted performance.

However, it's important to note that the Calmar ratio is not a definitive measure of an investment's performance. It's just one tool among many that investors can use to assess the risk and return of an investment. Other factors, such as the investment's volatility, liquidity, and correlation with other investments, should also be considered.

### Limitations of the Calmar Ratio

While the Calmar ratio is a useful tool for assessing the risk-adjusted performance of an investment, it's not without its limitations. One of the main limitations is that it only considers the maximum drawdown, not the frequency or duration of drawdowns. This means that an investment with frequent but small drawdowns could have a higher Calmar ratio than an investment with infrequent but large drawdowns.

Another limitation is that the Calmar ratio assumes that the past performance of an investment is indicative of its future performance. This is not always the case, especially in volatile markets. Therefore, while the Calmar ratio can provide valuable insights, it should not be used as the sole basis for investment decisions.

## Calmar Ratio in Trading

In the world of trading, the Calmar ratio is often used to assess the performance of trading strategies. A high Calmar ratio indicates that a strategy has a good risk-adjusted performance, while a low Calmar ratio indicates that a strategy has a poor risk-adjusted performance.

Traders often use the Calmar ratio in conjunction with other performance measures, such as the Sharpe ratio, the Sortino ratio, and the Sterling ratio, to get a more comprehensive picture of a strategy's performance. This can help them to make more informed trading decisions and to manage their risk more effectively.

### Calmar Ratio vs Other Performance Measures

While the Calmar ratio is a useful tool for assessing the risk-adjusted performance of trading strategies, it's not the only tool available. Other performance measures, such as the Sharpe ratio, the Sortino ratio, and the Sterling ratio, also provide valuable insights into a strategy's performance.

The Sharpe ratio, for example, measures the excess return per unit of risk, while the Sortino ratio measures the excess return per unit of downside risk. The Sterling ratio, on the other hand, measures the average annual return per unit of maximum drawdown. Each of these ratios has its own strengths and weaknesses, and they are often used in conjunction to provide a more comprehensive picture of a strategy's performance.

## Conclusion

The Calmar ratio is a valuable tool for assessing the risk-adjusted performance of investments and trading strategies. By taking into account both the potential returns and the potential risks, it provides a more comprehensive picture of an investment's performance than measures that consider only one or the other.

However, like all performance measures, the Calmar ratio has its limitations and should not be used as the sole basis for investment decisions. Instead, it should be used in conjunction with other performance measures and factors to make informed trading decisions.

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