I have understood from working with many traders over the years that “Expectancy” is one of the few terms truly understood by many people who wish to learn how to trade successfully.
Expectancy refers to what you can expect to earn on average per trade/per day/per week etc. Of Course on the other hand it can also highlight before hand whether your expectancy is to LOSE! Typically most traders that will back test trading systems would be very interested in this figure (Or should be!). However many discretionary traders totally forget/ignore or worse just don’t understand how important this concept is to their own trading. Expectancy is more important than Risk to Reward ratio (Pay Off ratio) and Win/Loss Percentages alone.
The Calculation for expectancy is very simple. Firstly you need to keep/have a Record of:
- Your Per trade/day Win%.
- Your Average Winning trade/day.
- Your Per trade/day Loss%.
- Your Average Losing trade/day.
The Calculation for Expectancy is: EXPECTANCY = (Average Gain x Win %) – (Average Loss x Loss %)
An Example for an Average Daily Expectancy for a trader that has traded 6 months with a record of 80% of days with a positive gain and a 20% of days with a loss. Average Gain per Day (Total Revenue from Up Days/Number of Up Days) being $1200, Average Loss per day (Total Cost from Down Days/Number of Down days) being $500
Average Daily Expectancy = (1200 x 80%) – (500 x 20%) = 960 – 100 = $860
Knowing this the above trader can be more comfortable and confident that they can expect to gain on frequent days (Note not all!) with a positive expectancy. I have personally found that my Up days generally fall just above/below expectancy on MOST days, however not all. Some days we have to accept that we may have a down day, of course some days we will hit our main objective and every now and again we can also expect some outliers with exceptional days that exceed our targets. Taking all of the above into consideration, it is important to note that this is assuming the trader keeps on performing well. It is the responsibility of the trader to make Risk/Objective adjustments as and when required as Expectancy is a Dynamic and constantly changing figure, however over time you will find that for quite some time it sits around a Monetary value that you start achieving frequently. You can also do the above for each week or month. For day traders weekly expectancy is worth tracking, for longer term traders the monthly figures may become more useful. Whatever you do you should know it so that you can move forward with confidence.
For the Expectancy to be meaningful you should have a minimum of at least 40 Trades/Days. Ideally at least 3-6 months of continuous recorded performance. If you keep an up to date record of your trades you will know your Average Expectancy per trade/day in advance. I show people how I do this in our L2ST online trading room. Personally I am interested in daily figures (although per trade are recorded for reference). However newer traders may want to gain more detail to help improve performance by initially looking at the figures for each individual trade. However I believe that each individual trade is so insignificant in itself, and having a positive expectancy per trade although important is less important than having A Daily/Weekly Positive Expectancy. Daily Expectancies are achieved more often than per trade, also per week expectancies can be hit VERY consistently if you do things right. Having a Positive Daily/Weekly Expectancy over time is very powerful because you can gain the confidence in the fact that you can Expect to be Consistently Profitable with a Positive Expectancy. On the other hand a Negative Expectancy is a wake up call to stop trading live, as it makes no sense risking real money whilst you expect to LOSE! Common Sense really, but you would be surprised at how many traders will ignore the Negative Expectancy Alarm bells! If you have performed to the point where Expectancy becomes negative then its time to drop size to as small as you can trade whilst you focus on improving performance or you can move to sim trading until you complete performance over a period that highlights a positive expectancy again.
I commonly recommend that traders work with Daily Financial Objectives to prevent Greed, Over Trading scenarios and worse giving back good gains consistently, and instead encourage Visualizations of achieving those objectives consistently. If and when you want to aim for more you simply increase your Goals/Objectives (A bit at time, no sudden jumps!). However Daily objectives are not always achieved even though they are the target. Just because you have something to aim for that doesn’t mean you will hit it! However this doesn’t mean you should not set them either! It just means that you should understand that if you may not expect to achieve your goal/objective every day, and you may lose on some days, then what can you expect to achieve more frequently? – Guess What… Your Daily Expectancy.
Author: Kam Dhadwar – Trader and Owner of L2ST