The formula for a profitable trade is the expectancy formula of a trading system.

Expectancy = ((PW * AW) - (PL * AL)) * F

  • PW: was the percentage of win
  • AW: average win
  • PL: is the percentage of loss (number of losing orders divided by total number of positions or taking 100 minus PW);
  • AL: average loss
  • F: frequency (ie the total number of orders entered in a year).
This expectancy calculated and positive is that the trading system has an advantage and will make a profit in the long term (in years), but if it is negative, the system will make you LOSE money in your assets. clause.

For example, expectancy is 2.1, which means that for each trade passed, you earn an average of 2.1 USD, pretty good, right? If the expectancy is -1.5, it means that each trade passes, your account will lose 1.5 USD, and gradually it will burn out.

This formula should be calculated with a large number of samples, that is, with the number of entries you have to be about 100 or more for the number to be correct. The larger the sample number, the more realistic the results are.

Now let us try to rate 4 traders with different parameters:

trader A: PW = 80%, profit / loss ratio = 0.1 (ie earning 100 USD per winning order, losing 1000 USD per losing order); frequency = 250 / year. Result: negative expectation despite an 80% win rate!

trader B: W% = 30%; P: L ratio = 2: 1 (+1,000: -500); Frequency = 150. Outcome: negative expectations despite 2: 1 profit / loss!

trader C: W% = 45%; P: L ratio = 2.5: 1 (2,500: -1,000); Frequency = 35. Outcome: highest expectations per position

trader D: W% = 43%; P: L ratio = 2.4: 1 (2,400: -1,000); Frequency = 250. Outcome: highest expectations per year.

The summary of the trading results of 4 traders in the following table:

All traders want to be trader A when they first start trading, because they want to win as many times as possible (with the highest win rate), and they are very afraid of losing. Later, they learn that the key is having big wins, so they want to become trader B (high profit / loss). Then they realize that they need to improve the balance of both win and profit / loss as well, so they want to become trader C (start making profits). Finally, the best trader learns how to solve the problem, balancing the winrate and profit / loss, plus increasing the frequency (the number of orders to enter), the profit will become huge.

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