Hey guys,
I’m just taking a look at expectancy right now. There isn’t much online that I could find about it without having being bombarded with advertisements and signal services…
So far, I’ve found two formulas for expectancy:
E = [1 + (W/L)] x P-1
Where:
W= Average winning trade
L= Average losing trade
P= Percentage win ratio
And:
Expectancy = (Probability of Win * Average Win) – (Probability of Loss * Average Loss)
I’m assuming both will give out the exact same results, too lazy to do algebra right now. =P
Assuming I am currently trading with a 50% win rate, and achieving a 2.5:1 reward to risk ratio each trade, how would I go about calculating this? I see calculators online that will give me a percent or a dollar value.
My answer on expectancy is I use the first calculation you printed. On my share trading spreadsheet that I’ve had for years the comment next to the expectancy figure is “keep above .3”
Now what does the figure actually mean. Now if we change the pips to dollars, and every trade you did was a $1 pip, therefore with your calculation, $75 win or $30 loss, 50% win rate = .75 as you mention. Now in simple terms for every dollar you invest you will return .75cents, which would be a great return.
The most important thing to understand is what this expectancy is over a large sample, because if you figures are based on 20 or 30 trades, then the number will be distorted.
For your second calculation, I found this that might explain a little further.
A most important formula for our trading is the Expectancy Formula. Its basic formulation is in dollars terms.
(Average Dollar Win/Win Rate) - (Average Dollar Loss/Loss Rate) = Expected Profit per Trade
Let’s say:
•My AVG$win is $75.00
•My Win rate is 50%
•My Avg$ loss is $30
•My Loss rate is 50%
•My avg trades per year is 300
My expected $ profit would be: $22.50 per trade
$((75 x .50) - $(30 x .50)) = $22.50
Now add trade frequency to the calc, eg 300
$(22.50 x 300) = $6750
Lastly, I think expectancy is the most important calculation you can apply to trading as it proves to you whether your system is profitable for the dollar outlayed. That’s why as you will see with the link so many focus on win rate % but don’t understand this in combination with avg win $ vrs avg loss $. If you apply this to your trading now you will now focus on the expectancy calculation and not the system perse and therefore the holy grail, in my opinion.
Thanks Smithy for the thorough explanation, really helped me out.
Just out of curiosity though, what would a recommended expectancy amount be? Of course it has to be positive and anything is better than nothing; I understand all that.
But it would be nice to be given a number to aim for. Currently my trading expectancy is 0.75, how would you grade this in terms of trading?
The original response may not have been clear but I would say anything over .3 would be good, I would say .75 would be great.
What sort of sample size have you got on your stats so far for that calculation?
To think of it in simple terms, if you make .3 or 30% on every dollar you spend, then the other factors to come into to play are either increase trade size but still following correct money management procedures or increase trade frequency, as long as it fits within the system criteria that your expectancy is calculated from.
Awesome thanks for the reply smithy, I really appreciate it.
The expectancy rate I’m getting is based off of the 148 trades I have taken on my live account. What would you suggest for an optimal sample size? I have it automatically calculated on my spreadsheet as I trade more it adjusts according.
Trying to stay consistent is my main goal, so perhaps keeping a consistent expectancy of above 0.30 is a good guideline to start.
I don’t mean to go offtopic in here. But since the Forex Market, or any financial market for this makret, allows for a fixed distribution of probabilities, this means that the market is always dynamic, no much as a roulette table where the designer, made it in a way to give predictable fixed odds.
What this means is whatever winning ratio you got for 10 years, can stop working… NOW… or … TOMORROW… or in 1 YEAR, it doens’t matter, my point is, how can you factor in this reality into our long term expectancy, because the truth is, the markets are simply too chaotic, and we are playing with odds, here, and not casino odds, but very dynamic and changing odds.
Now my question is, is there any way to know before hand when our system will be rendered obsolete or not?