Tracking Error Formula: What Forex Traders Need to Know

Tracking Error Formula: What Forex Traders Need to Know

What Is Tracking Error Formulae in Forex?

Tracking error formulae in forex is a key part of portfolio analysis, which traders use to evaluate the expected returns/” title=”High Interest Business Savings Accounts: Maximize Your Returns”>risks on expected returns before taking on a trade. It measures the deviation of an individual trading portfolio “P” from the benchmark “B”, by calculating the standard deviation of the difference between their respective returns. In simpler terms, it is an assessment of how well a portfolio measures up against its benchmark index.

Tracking Error formulae are procedurally speaking, relatively simple. It is calculated by measuring the volatilities of the differences in returns between “P” and “B”. Firstly, the total return gains of the individual portfolio and its benchmark are calculated. The trading portfolio’s return is subtracted from its benchmark’s return, resulting in an estimation of the portfolio’s excess return over the benchmark. In addition, excess return is also known as active return and is the estimated outperformance in comparison to the benchmark, given the same amount of invested capital. Afterwards, the average volatilities of the excess return are then measured, revealing the average difference of each trading portfolio’s performance from its benchmark over a set time period.

What Are The Benefits of Knowing The Tracking Error Formulae?

Knowledge of the tracking error formula is beneficial for traders as it arms them with the necessary skills to calculate the potential risks of their trading portfolios. Having awareness of the formula also provides a more precise way of making accurate portfolio analysis with concrete data and exact figures. On top of that, traders will be able to maximize their profits by using the formula to reduce the volatility of their trading portfolio in comparison to the benchmark. Moreover, it can be used for different types of trading investments, such as stocks, bonds, and commodities, so traders would be able to identify exactly the amount of risk present in different trading investments.

Additionally, understanding the tracking error formulae can help traders in being more disciplined with their trading strategies as it helps traders assess how much outperformance or underperformance should be expected. Moreover, it also aids traders in monitoring potential moves, improvements or reforms to be made to their own trading portfolio for better returns. In short, the tracking error formula serves as an essential tool for traders to monitor their trading portfolios.


In conclusion, the tracking error formulae in forex is a formula used by traders to calculate the expected risks and returns of their trading portfolio. It’s ideal for traders to understand and use the formula as it can be employed to generate more accurate portfolio analysis, reducing the volatility of the portfolio in comparison to the benchmark and helping to identify the amount of risk present in different trading investments, as well as to detect potential moves or reforms. All in all, the tracking error formula is an essential tool for any trader.

What Is a Tracking Error Formula?

Tracking error is a measure of financial performance that determines the difference between the return fluctuations of an investment portfolio and its benchmark. The formula for tracking error indicates how closely a portfolio follows its benchmark. This is used by investors to assess the performance and risk of their portfolios. It is used by fund managers and investment advisors to decide between active and passive portfolio management styles.

To calculate the tracking error formula, one subtracts the benchmark’s return from the portfolio’s return. Then each value is squared and the results of each period are added together. Finally, the sum is divided by the number of periods, and the final result is the tracking error.

What Does Tracking Error Measure?

Tracking error measures how closely a portfolio follows its benchmark and is expressed as a percentage. The higher the tracking error, the more deviation from the benchmark. Higher deviations indicate higher risk. It is important to remember that tracking error is only a measure of performance and not an indication of quality. An investor should take into account other factors such as underlying management style and management fees when making decisions.

It is used as an indicator of how well fund managers are performing. For example, if a portfolio is 10% below its benchmark, then the tracking error would be 10%. If a fund manager can consistently bring in returns that beat the benchmark by more than the tracking error, then it is deemed to be a good performance. On the other hand, a high tracking error relative to the benchmark usually indicates that the fund manager is not doing a good job.

How Is the Tracking Error Formula Used?

The tracking error formula can be used to compare a portfolio’s returns against its benchmark. It is most useful for long-term investments, where it can be used to measure a fund manager’s skill in managing a portfolio. A fund manager’s ability to minimize tracking error is evidence of their ability to manage the portfolio efficiently.

Tracking error can also give investors information on whether the fund is replicating its benchmark. If the tracking error is too large, then this could mean the fund is not following the benchmark closely enough, and the investor may want to reallocate their funds to a better-performing manager.

The tracking error formula is one of the most important indicators of a portfolio’s performance and can be used to evaluate the effectiveness of a fund manager’s strategy. It is important for investors to understand the formula and how to interpret its results in order to assess the risk and potential rewards of their investments.