**PROFIT EXPECTANCY**

If you read any basic book on trading you will have it ingrained in your head that one must only take a trade if the profit is greater than the risk taken. In reality, I know many successful traders who regularly risk more than they make on any given trade but what these traders do understand is the profit expectancy of their system/strategy. Most retail investors only focus on entry and exit and standard risk/reward for their trades and a true understanding of the expectancy of a strategy often goes awash. Profit expectancy refers to how much you can make vs each pound (GBP) risked on a trade.

**PROFIT EXPECTANCY EQUATION**

**AVERAGE PROFIT PER WINNER * PROBABILITY OF A WINNER**

**MINUS (-)**

**AVERAGE LOSS PER LOSING TRADE * PROBABILITY OF LOSING**

**= HOW MUCH PROFIT PER TRADE YOU WOULD EXPECT TO AVERAGE OVERTIME**

We can use a previous example of my lifestyle trades as a case example. This is one of my systems where I regularly risk more than I gain on any one trade. On face value, this would get scrutinised by a retail investor but by applying the above formula one can see that the overall strategy is very profitable.

BUY OR SELL |
STOP |
TARGET |
WIN/LOSS |
PROFIT/LOSS |

SELL at 5679 | 22 | 5650 WIN | 29 | |

SELL at 5723 | 22 | 5694 WIN | 29 | |

SELL at 5767 | 19 | 5753 WIN | 14 | |

SELL at 5808 | 23 | 5791 WIN | 17 | |

SELL at 5890 | 18 | 5870 LOSS | (-) 18 | |

SELL at 5920 | 17 | 5890 WIN | 17 | |

SELL at 5935 | 15 | 5917 WIN | 18 | |

SELL at 5927 | 15 | 5921 WIN | 6 | |

SELL at 5814 | 18 | 5793 LOSS | (-) 18 | |

SELL at 5922 | 17 | 5914 WIN | 8 | |

BUY at 5852 | 19 | 5868 WIN | 16 | |

BUY at 5794 | 19 | 5806 WIN | 12 | |

SELL at 5884 | 22 | 5876 WIN | 8 | |

BUY at 5823 | 21 | 5836 LOSS | (-) 21 | |

SELL at 5716 | 22 | 5705 WIN | 11 | |

BUY at 5578 | 27 | 5593 WIN | 15 | |

BUY at 5665 | 25 | 5674 WIN | 9 | |

SELL at 5747 | 23 | 5733 WIN | 14 | |

SELL at 5725 | 24 | 5702 WIN | 23 | |

SELL at 5737 | 22 | 5718 LOSS | (-) 22 | |

SELL at 5789 | 21 | 5777 WIN | 12 | |

BUY at 5556 | 27 | 5580 LOSS | (-) 27 |

**EXAMPLE**

For the above data we will see there are 22 overall trades of which 17 are winners and 5 are loses. This provides a win rate of 77% and a loss rate of 23%

The average loss is 21 points and the average win is 15 points

If we assume we are trading 10 pounds a point for each trade.

If we apply this data into the above formula we get:

(150*0.77) = 115

minus

(210*0.23) = 48

115 – 48 = 67

Any system with a profit expectancy over zero makes money over time

So even though we are risking more on this system we have a profit expectancy of 67 pounds for each trade over time.

I prefer adopting a strategy which has a high win rate to keep my confidence high however you could have a strategy with a 23% win rate and still be profitable but what is vital is you understand the profit expectancy of your system/strategy rather than just focusing on risk/reward. Remember trading is a business and without working out expectancy in your strategy, you do not have a complete business plan.

Happy Trading!

Mark

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