Trading 101: Expectancy
Expectancy = (Probability of Win * Average Win) – (Probability of Loss * Average Loss)
As an example let’s say that a trader has a system that produces winning trades 30% of the time. That trader’s average winning trade nets 10% while losing trades lose 3%. So if he were trading $10,000 positions his expectancy would be:
(0.3 * $1,000) – (0.7 * $300) = $90
So even though that system produces losing trades 70% of the time the expectancy is still positive and thus the trader can make money over time. You can also see how you could have a system that produces winning trades the majority of the time but would have a negative expectancy if the average loss was larger than the average win:
(0.6 * $400) – (0.4 * $650) = -$20
In fact, you could come up with any number of scenarios that would give you a positive, or negative, expectancy. The interesting thing is that most of us would feel better with a system that produced more ----winning trades than losers.
And with the conclusion, there are only 4 variables that we can tweak around, and should be paying full attention in order to improve our trading system.
| - increase your winning trades (Winning probability) - increase your winning +R value per trade (Average win) - reduce your losing trades (Losing Probability) - reduce your loosing -R value per trade (Average Loss) |
These 4 areas will be the Holy Grail of all trading systems.
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My Path to 100 R in Profits from Day Trading
Dr. Tharp reveals the great secret of trading:
The golden rule of trading is to keep losses at a level of 1 R as often as possible and to make profits that are high-R multiples.
