Positive Expectancy

If the term positive expectancy is new to you – don’t worry. You may already know this, but by a different name. Keep reading to be sure.

And if the notion is completely alien to you … fear not. It is simple to grasp. But please do make it a priority to fully understand this concept. It really is a vital part of building a successful future in trading.

Positive expectancy is simply how much money, on average we can expect to make for every £ that we risk.

And here I’ll show you the simple way to work this out …

But first, many traders get mixed up between positive expectancy and risk-reward ratios

The two are related, but not the same – and it’s important to understand risk-reward before you understand positive expectancy … so, if you haven’t already, I’d urge you to start off with this post .

Positive expectancy is the combination of risk-reward and success rates that tells us whether we have a profitable strategy or not. By focusing on this, rather than on ‘being right’ or ‘having that holy grail 2:1 ratio’ – we are keeping our attention on what matters – making a profit.

Expectancy doesn’t care if you ‘had that great winner back in November’ … or if you ‘got a record breaking winning run’. It just looks at the bottom line.

Here’s how we calculate it …

Expectancy = (probability of winning x average win) – (probability of losing x average loss)

Bear in mind that your ‘average win’ and your ‘average loss’ are probably not simply where you put your profit target and stop level – if you sometimes close trades early, or suffer from slippage.

And what we’re after is a positive figure for our expectancy – this means that we’re in the black.

Here’s how it works in practise …

Let’s say that, after reviewing 150 trades, I determine that I’ve won 68% of them and lost 32% of them. My average winner has been £188. My average loss has been £235. This gives me a risk-reward of 1:1.25

I calculate my expectancy like this:

E = (0.68 x 1) – (0.32 x 1.25)

E = 0.28

You don’t need a huge sample to start recording your positive expectancy – as with any stats, the larger the sample the better, but we all need to start somewhere.

If you’re not yet recording this kind of data, then please download the Trader’s Bulletin journal, which should get you started.

Related posts:

Probability Risk-Reward