Expectancy
Definition
Average amount expected to win or lose per trade.
Expectancy, in the context of trading, is a measure that quantifies the average amount expected to win or lose per trade. It's a key metric used to evaluate the potential profitability of a trading strategy, taking into account both the win rate and the risk-reward ratio.
How It Works
Expectancy is calculated using the following formula:
Expectancy = (Win Rate * Average Win) - (Loss Rate * Average Loss)
Where:
- Win Rate is the percentage of winning trades
- Average Win is the average amount won per winning trade
- Loss Rate is the percentage of losing trades (100% - Win Rate)
- Average Loss is the average amount lost per losing trade
For example, if your win rate is 60%, average win is $500, average loss is $300, then:
Expectancy = (0.6 * $500) - (0.4 * $300) = $120
Why It Matters
Expectancy is a crucial concept for traders as it helps to:
- Assess the potential profitability of a trading strategy
- Compare different strategies
- Identify the need for improvement in win rate, average win, or risk-reward ratio
- Make informed decisions about risk management and position sizing
Even a small improvement in expectancy can lead to significant long-term gains, making it a valuable tool for traders at all levels.