Understanding Trade Accounting Methods: FIFO, LIFO, and Weighted Average

When tracking trading performance, how you calculate your returns can significantly impact your reported results. Many traders encounter confusion when comparing their platform’s calculations to their broker statements or tax documents. This article explains the differences between common trade accounting methods and how they affect your reported performance.

The Core Issue: Trade Accounting Methods Are Not Equal

Perhaps the most important point to understand is:

The overall P&L of a completed trade is always the same (total sales proceeds minus total purchase costs), but the P&L calculated at intermediate points may vary significantly depending on which accounting method you use.

Let’s explore why this happens and how each method works.

Three Common Trade Accounting Methods

1. FIFO (First-In, First-Out)

FIFO assumes that the first shares you purchased are the first ones you sell. This is the most commonly used method and is the default for tax purposes in many jurisdictions.

How it works:

• Buys are organized chronologically
• When you sell, the system matches against your oldest purchases first
• Returns are calculated based on these specific matches

2. LIFO (Last-In, First-Out)

LIFO assumes that the most recent shares you purchased are the first ones you sell.

How it works:

• Buys are organized chronologically
• When you sell, the system matches against your newest purchases first
• Returns are calculated based on these specific matches

3. Weighted Average

The weighted average method doesn’t track individual lots. Instead, it calculates an average cost basis for your entire position and uses that for all sales.

How it works:

• Each buy updates your average cost basis
• When you sell, return is calculated against the current average cost
• No specific matching of buys and sells

Why The Methods Produce Different Results: An Example

Let’s look at a simple example with three executions:

Execution	Action	Shares	Price	Total
1	Buy	100	$10	$1,000
2	Buy	100	$15	$1,500
3	Sell	150	$13	$1,950

Overall Trade P&L

Regardless of accounting method, the overall position (which is still open with 50 shares) has the following P&L:

• Total Cost: $1,000 + $1,500 = $2,500
• Total Sales: $1,950
• Current Position: 50 shares
• P&L on Closed Portion: $1,950 – (150/200 × $2,500) = $1,950 – $1,875 = $75

However, the realized P&L at execution #3 will differ by method:

FIFO Calculation

Using FIFO, the sale of 150 shares would be matched against:

• 100 shares from execution #1 (cost basis: $10 per share)
• 50 shares from execution #2 (cost basis: $15 per share)

P&L = $1,950 – (100 × $10 + 50 × $15) = $1,950 – ($1,000 + $750) = $1,950 – $1,750 = $200

LIFO Calculation

Using LIFO, the sale of 150 shares would be matched against:

• 100 shares from execution #2 (cost basis: $15 per share)
• 50 shares from execution #1 (cost basis: $10 per share)

P&L = $1,950 – (100 × $15 + 50 × $10) = $1,950 – ($1,500 + $500) = $1,950 – $2,000 = -$50

Weighted Average Calculation

Average cost basis after executions #1 and #2:

• $2,500 ÷ 200 shares = $12.50 per share

P&L = 150 shares × ($13 – $12.50) = 150 × $0.50 = $75

Notice how each method produces a different result for the same trade at this interim point!

The Execution Order Problem

An additional complication arises when a single order is broken into multiple executions. Many brokers don’t clearly specify the exact time sequence of these executions, which can create ambiguity on TraderSync.

Let’s see how changing the order of executions in our example affects the calculations:

Original Order:

1. Buy 100 shares at $10
2. Buy 100 shares at $15
3. Sell 150 shares at $13

FIFO P&L: $200
LIFO P&L: -$50

Alternative Order:

1. Buy 100 shares at $15
2. Buy 100 shares at $10
3. Sell 150 shares at $13

FIFO P&L: -$50 (now matching against the $15 purchase first)
LIFO P&L: $200 (now matching against the $10 purchase first)

The execution order completely reverses the results! Yet the weighted average result remains $75 in both scenarios.

A More Complex Example

Let’s examine a more realistic scenario with multiple executions:

Execution	Action	Shares	Price	Total
1	Buy	300	$50	$15,000
2	Buy	200	$45	$9,000
3	Sell	250	$55	$13,750
4	Buy	150	$60	$9,000
5	Sell	400	$58	$23,200

FIFO Calculation

Each sell is matched against the earliest buys:

• Sell #3 (250 shares): Matched against execution #1 (250 shares at $50)
• P&L: $13,750 – $12,500 = $1,250
• Sell #5 (400 shares): Matched against execution #1 (50 shares at $50), execution #2 (200 shares at $45), and execution #4 (150 shares at $60)
• P&L: $23,200 – ($2,500 + $9,000 + $9,000) = $23,200 – $20,500 = $2,700
• Total FIFO P&L: $1,250 + $2,700 = $3,950

LIFO Calculation

Each sell is matched against the latest buys:

• Sell #3 (250 shares): Matched against execution #2 (200 shares at $45) and execution #1 (50 shares at $50)
• P&L: $13,750 – ($9,000 + $2,500) = $13,750 – $11,500 = $2,250
• Sell #5 (400 shares): Matched against execution #4 (150 shares at $60) and execution #1 (250 shares at $50)
• P&L: $23,200 – ($9,000 + $12,500) = $23,200 – $21,500 = $1,700
• Total LIFO P&L: $2,250 + $1,700 = $3,950

Weighted Average Calculation

• After executions #1 and #2: 500 shares at average cost of $48 per share
• After sell #3: 250 shares remaining at $48 per share
• After buy #4: 400 shares at average cost of $52.50 per share
• After sell #5: 0 shares remaining
• P&L from sale #3: 250 × ($55 – $48) = $1,750
• P&L from sale #5: 400 × ($58 – $52.50) = $2,200
• Total Weighted Average P&L: $1,750 + $2,200 = $3,950

Overall Trade P&L

• Total Purchases: $15,000 + $9,000 + $9,000 = $33,000
• Total Sales: $13,750 + $23,200 = $36,950
• Net P&L: $36,950 – $33,000 = $3,950

Note that while all three methods yield the same final P&L for the completed trade, the interim P&L calculations differ significantly, which can affect your performance metrics if you’re analyzing partial positions or specific time periods.

What This Means for Traders

1. Understand your broker’s methodology: Different brokers may use different accounting methods for reporting. Know which one your broker uses.
2. Be consistent: Choose one method and stick with it for performance tracking to ensure consistent analysis.
3. Execution timing matters: When a single order is split into multiple executions, the exact sequence can significantly impact FIFO and LIFO calculations.
4. Consider using weighted average: If you’re primarily concerned with overall performance tracking and not tax implications, weighted average provides the most consistent measurement and is less affected by execution sequencing issues.
5. Mind the gaps: If your broker doesn’t provide precise execution sequencing, there may be unavoidable discrepancies between TraderSync calculations and your broker statements.

Conclusion

Understanding trade accounting methods is essential for accurate performance tracking and analysis. While FIFO, LIFO, and weighted average will all yield the same result for a fully closed position, they can show dramatically different performance during the trade.

TraderSync strives to provide the most accurate calculations possible, but without precise execution sequencing from brokers, some variation is inevitable. Being aware of these differences will help you better interpret your trading performance and make more informed decisions.