The interest paid on leverage and the interest earned on cash. At non-zero rates it is a first-order term that many backtests silently set to zero.
A strategy running 2x gross exposure funds one unit of capital at the broker's rate. At 6%, that is 6% a year of drag before any trading happens, which turns a respectable 9% gross into 3% net.
The sign can also be positive. A strategy holding large cash balances or fully collateralised futures earns the risk-free rate, and much of the reported long-run return of some managed futures programmes historically came from exactly that.
Model the rate as it was historically, not as it is today. A backtest spanning 2009 to 2021 at today's rates would misstate financing every single year, in whichever direction happens to flatter the result.
Original diagrams for the ideas on this page. Illustrative, not real market data.
Margin and leverage. A $5,000 deposit can control a $100,000 position, which is 20:1 leverage. Because the loss is measured on the full $100,000, a 2.5% move against you halves the deposit and brings a margin call, and a 5% move uses all of it.
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