In this post I will explain the concept of expectancy in trading, an important number to track if you’re serious about your trading.
What is Expectancy?
Expectancy in trading is a formula used to calculate / determine how profitable a trading system is over a period of time. Stated differently, expectancy is how much a trader can expect to make on average over a large number of trades.
As it helps to determine the profitability of a trading system over a series of trades, past trades (journaling is important to keep track of your expectancy) are used to calculate expectancy. This in turn can help traders to determine how effective their strategies are.
The Formula:
The following formula can be used to calculate expectancy:
Expectancy = (Win Rate x Average Win) – ((1 – Win Rate) x Average Loss)
As an example, let’s say a trading system has a 55% win rate, an average profit of $110 and an average loss of $50. If we us the formula above, the expectancy can be calculated as follows:
Expectancy = (0.55×110) – ((1-0.55)x50) = $38, which means over a long period of time this system can expect to make $38 per trade.
More on Expectancy:
Positive expectancy means that your trading system should make money over the long term, assuming your risk is reasonable and you are executing your trading strategy with consistency. On the other hand, negative expectancy means your strategy should lose money over the long term.
With a trading system that’s got a positive expectancy, losses in the short term shouldn’t bother you because you know what to expect in the long term. Expectancy helps you to think in probabilities.
The main ways to improve the expectancy of a trading system is by improving your win rate and reward to risk of your trades / trading system.
Finally:
If your trading strategy’s expectancy is positive, losses shouldn’t bother you. All you have to do is think long term, keep executing your strategy without deviating from your strategy, knowing that probability is in your favor.
Thanks so much for reading.
Trading SOS SOS