WHAT IS EXPECTANCY?
Expectancy is the key to profitable trading. Understood by few, it is used by all profitable traders. To be a profitable trader you need to have a positive-expectancy trading system.
To understand expectancy first you need to think about your trades in terms of the rewards you may earn for the risk you’re taking: a reward-to-risk ratio.
What is the risk of your trade?
What is the reward of the trade?
This relationship between the two is what we call the Reward-to-Risk ratio.
I like to call the risk R – short for Risk, so it's easy to remember. The unit of R can be dollars: for example, a $100 risk on the trade. Or it can be a percentage of your trading account: your risk on the trade is 1% of your trading account. Reward is what you get if the trade is successful. For example a $200 gain, or 2% gain on your account. If your Risk is $100 to get a Reward of $200, then your reward-to-risk ratio is 2/1 or 2R. Simple enough.
To know the expectancy of your trading system we now need to know how often you will get your reward and how often you will have to pay the price – the risk – for getting it.
Let's look at an example.
Image your trades are marbles and they are placed in this black bag. In the bag we have 100 marbles ( a hundred possible trades):
40 green marbles (40 winning trades)
60 red marbles (60 losing trades)
For each green marble drawn from the bag you get +2R; for each red marble drawn from the bag you get -1R. With this information we can now easily calculate the expectancy of this trading system.
40 times +2 = +80
60 times -1 = -60
The net result for this system is therefore +20R. Since we have 100 marbles in the bag we divide the net result by 100 and get the expectancy for each marble trade: 0.20R. On average this system is expected to make 0.20R per trade.
Since you know the expectancy you can now get a rough estimate of how much you would make over a given number of trades.
For example, if you take 1,000 trades like this and risk $100 on each one, with an expectancy of 0.20R per trade, your expected gain after 1,000 trades is $20,000 (1,000x100x0.2) Do you see why it's called “expectancy”? It gives you an idea of what to expect from your system.
You could calculate the expectancy for your systems and all its variables yourself. You’d have thousands of lines in your Excel spreadsheets and spend hours each day recalculating the expectancy of your system as the markets are moving and generating trading signals 24/7. But this is not good use of your time. Algorithms can do this for you in a fully automatic way. This is a perfect job for an algorithm.
Our algorithms calculate the expectancy for trading systems and we do it in real time. As the market moves and new data is gathered, new signals are created – we continuously calculate the expectancy for a trading systems and send this information to the trader in real time as and when new signals are generated in live markets.
To calculate the expectancy for your strategy you can use the FREE google sheet below.
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