forex trading

What is expectancy in forex trading?

Daksh Murkute | | |

Everyone says that trading should be done with an edge. But what exactly is this edge and how to know if we have that edge or not?

 

This is where the thing of trading expectancy comes in. It is an important trading metric that can literally tell you if your strategy or system is good or not and whether you have an edge.

 

In this blog post, I will be simplifying this concept of expectancy for you and you’ll also learn to calculate the expectancy for your system so that you know for sure if it’s worth trading with or not. So stick around till the end.

Contents

 

 

What is expectancy?

 

What is expectancy?

 

Expectancy is a metric that tells you how much you can expect to make in each trade you take with the strategy or how profitable a system is.

 

It tells you how good or poor the system is and if it’s worth it for you to trade.

 

If you actually go on to find trading strategies, then I’m sure you’ll find loads of them and each one of them will have their distinct things that’ll help you capitalize in the forex market or any other market.

 

But, should you trade each of one them, or instead should you pick any random strategy and start trading with it? No, not at all.

 

You should only trade a strategy that has an edge and calculating the expectancy of the strategy or system will help you know if there’s an edge or not.

 

 

Why should you know your system’s expectancy?

 

Why should you know your system?s expectancy?

 

The real edge is profitability. Anyone can trade and be breakeven, that’s not an edge. Real edge is where you trade and are profitable.

 

Now, some traders just look at a system’s win rate or the risk to reward ratio to know if the strategy is good enough or not.

 

Well, that’s not really the right thing to do. I had uploaded a blog post earlier in which I talk about seeing win rate together with risk to reward ratio. With calculating expectancy, we will be going a step further.

 

The problem, or not really a problem but a slight issue with looking at just the win rate or the RRR is that it can change from time to time.

 

You might have a 90% win rate in one month but right in the second month, it might go down to just 50%.

 

On the other hand, RRR is something that the market gives you and not something that you take from the market. I have got trades with a 1:5 RRR and even trades with a 1:1.5 RRR trading the same strategy.

 

The win rate and RRR will be high when the market conditions are suitable for your strategy but when conditions change, your win rate and RRR will be affected.

 

So, what is the better thing to look at to get a better picture or a more reliable picture? Expectancy.

 

And I’ll show you how exactly you can calculate the expectancy of your system.

 

 

How to calculate a system’s expectancy?

 

How to calculate a system?s expectancy?

 

So when it comes to calculating the expectancy of a system, you need some sample size. What is the sample size? It is some trade data.

 

A good place to start with is to a record of 50 trades where you know exactly how much profit was made and how much money was lost.

 

If you see, in the calculation of expectancy, you’ll be using your win rate as well as the RRR to some extent.

 

There’s a formula for the calculation of expectancy and it goes like this,

 

Expectancy = (win% x average win) - (loss% x average loss)

 

You need to know how many trades were winners, how many were losers, how much money did you make in the winning trades on average, and how much you lost in the losing trades on average.

 

Let’s understand this better with an example.

 

Let’s say that you trade the order block strategy, reversal trading strategy, breakout trading strategy, just plain support and resistance, or any other strategy you have.

 

You take 100 trades with the strategy and have kept a record of it all. Out of the 100 trades, 65 trades ended up in the green while the remaining 35 ended up in the red. So your win rate or win% here is 65% and your loss% is 35%.

 

Now, you will earn some money in those winning trades right, and let’s say you profited a total of $26,000. On the other hand, you lost a total of $13,000 in the losing trades.

 

If you have a look at the expectancy formula you’ll see that we need to know average win and average loss which is nothing but the average money you made in each winning trade and the average money you lost in each losing trade.

 

In 65 trades you made $26,000 which comes out to be $400 profit per trade. In 35 trades you lost $13,000 which comes out to be a $200 loss per trade.

 

Now that we have all the pieces, let’s put all of this in the expectancy formula and see what we end up with.

 

Expectancy = (win% x average win) - (loss% x average loss)

= (0.65 x $400) - (0.35 x $200)

=260 - 70

=190

 

We’ve got a figure of 190 and what is this? This is the amount you can expect to profit from each trade with the system that you are trading. In short, this is your system’s expectancy.

 

 

Do you know your system’s expectancy?

So, do you know profitable your system is? Do you know how much money you can expect to earn in each trade that you take with your system?

 

If not, then you now know how to calculate this and I hope that you actually use it.

 

Don’t forget to share this blog post with others and also, feel free to ask any questions you may have in the comments section below and I’ll make sure to get back to it at the earliest.

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