By Taro Hideyoshi
The expectations is one of the aspects traders should take into their consideration when trading. I have mentioned to expectations many in many of my articles. In this article, we will dig a bit deeper in order to paint clearer picture in this topic.
The question “How much do you expect to earn on each trade on average over the long run from your trading system or method?” is a good one to describe what the expectation is in trading.
Of course, no one expects to lose. Therefore, the first thing you have to make sure is the system you are using must have a positive expectation. If your system has the positive expectation, it will ultimately generate you profits if you keep trading by it over enough time.
The following equation is a mathematical equation for positive expectation. The higher result, the more positive expectation you have.
E = (1 + (W / L)) x P – 1
Where:
E = Expectation
W = How much you gain when you win
L = How much you loss when you lose
P = Probability of winning
According to the equation, you will see that it does not only depend on percentage of winning trades but also the amount you gain from winning trades.
For example, assume a trading system has 50% wining trades. Now, assume the average winning trade is $500 and the average losing trade is $350.
E = (1 + (500/350)) x 0.5 – 1 = 0.214
For comparison, let considers another trading system that has only 40% winning trades with an average winner of $1,000 and average loser of $350.
E = (1 + (1,000/350)) x 0.4 – 1 = 0.543
The second trading system’s positive expectation is 2.5 times that of the first although it has much lower percentage of winning trades.
Let’s take a look in another aspect. The following equation is a mathematics equation mentioned in the book “The Complete Turtle Trader” by “Michael W. Covel”.
The equation calculates the expected value from trades.
E = (PW x AW) – (PL x AL)
Where:
E = Expected value
PW = Winning percent
AW = Average winner
PL = Losing percent
AL = Average loser
From the above example, the expected value from the first trading system will be as follow.
E = (0.5 x 500) – (0.5 x 350) = $75 on average per gain per trade
Also for the comparison, the expected value from the second trading system will be as follow.
E = (0.4 x 1,000) – (0.6 x 350) = $190 on average per gain per trade
Do you get a clearer picture of the expectations in trading now? Hopefully, you do.
About the Author
Taro is an experience trader who trades in stocks, futures, forex. He strongly focuses on technical analysis, trading systems and money management.
If you would like to find more articles on MetaStock Tutorials, MetaStock Formulas, Trading Systems and Money Management. Please go to MetaStock Trading System.
You would also find the list of recommended books for trading & investing at The Investing Books.
