Expectancy Return

BarroMetrics Views: Expectancy Return

In recent years, the Expectancy Return Formula has become the flavour of the month. The formula:

(Average Dollar Win x Win Rate) – (Average Dollar Loss x Loss Rate) = Expectancy Return

Where:

  • Expectancy Return: is the return we believe we’ll see per trade over a large sample size
  • Average Dollar Win: is the total dollars made/the number of winning trades
  • Win Rate is: the number of winning trades/total number of trades
  • Average Dollar Loss: is the total dollars lost/the number of losing trades
  • Loss Rate is: the number of losing trades/total number of trades

I have written about the formula in other contexts; but today I want to focus on what the Win Rate/Loss Rate tells us and what the Avg$W/Avg$L tells us.

The Win Rate/Loss Rate tells us how well we are reading the market. It’s a function of our market understanding and/or the relationship of  our understanding and the state of market i.e. is our understanding in Ebb State or Flow State (see http://tradingsuccess.com/blog/ebb-flow-how-to-identify-675.html). There is no doubt that my understanding of market action is much better than it was when I started trading 30 years ago. I am able to have some chance of being correct when I assess the future path a market may take. When I started 30 years ago, I could no more do this than pigs could fly. So what does this better understanding mean?

A low Win Rate or high Loss Rate tells us either that:

  • We need to improve our understanding i.e. get an education or
  • We are in Ebb State and we need to take defensive action until the state passes.

What is HIGH/LOW in this context? This depends on your trading timeframe and your past results. The shorter the timeframe, the higher the Win Rate and the smaller the AVG$Win. Understanding this relationship is key to improving our Win Rate.

What about the AVG$Win/AVG$Loss? What does that tell us?

The AVG$Win/AVG$Loss tells us how well we are executing the trades. When I am trading well, I seldom get stopped out: the reason is I recognise early that my perceived low risk opportunity exists in my mind rather than in reality; and as a result, I exit my position before the stop is elected. Needless to say, when trading well, the early exit is correct…by that I mean, my stop would have been hit but for the early exit.

So are the two elements as distinct as I have made them here? If you think about it, the answer must be ‘no’; the two, WinRate and AVG$Win do merge together. That said,  I do find it useful, for my journal reviews, to separate  them. By approaching them in this way, I have often been able to take the action I need to improve my bottom line.

5 thoughts on “Expectancy Return”

  1. To my understanding, assuming we have steady Win/Loss Rate:
    The Expectancy Return is useful ONLY when we have a constant risk/reward ratio, constant amount of risk/reward per contract, constant number of contracts per trade.

    If not, depending on our Equity size – thus the 2% size, also whether we are in the flow or ebb state, the Average Dollar Win and Average Dollar Loss will keep on changing.

    In that case, the Expectancy Return will not give us a return we believe we’ll see per trade over a large sample size.

    Am I right or wrong? 🙂

  2. Hi Paul

    Thanks for the comment.

    Actually we disagree.

    The whole point of the Expectancy Return Formula is so you don’t need to keep the size constant.

    If you think about why I say that, I’m sure you’ll work out the reason. But if you can’t, you’ll need to qualify for the Barros Swing seminar to find out my train of thought.

  3. Ray,
    Thank you for the post. I find your insights going below surface on how to analyze and utilize these metrics helpful. I am not sure I fully understand the 1st bullet under Win Rate.

    For 2nd bullet i.e., detecting Ebb state, I can do a delta of my current Avg Win Rate vs Avg Win Rate last few weeks/months. So my comparable here is past Avg Win Rate.

    But for 1st bullet i.e., measuring my improvement, what would be a good comparable to my current Avg Win Rate? Would it be general average win rate of intraday trend pullback methods? But those rates vary from high % to low % depending on stops etc.

    Other option is given I am a junior trader, I already know there is still long way to go in improving my market read. So in that case, would it make sense just to aim for an overall up trending avg win rate % curve with assumption dips in curve mean poorer market read on my behalf for that period.

    Regards

  4. Hi D

    Thank you for your comments. I’ll expand on my ideas in the next blog and cover the questions you raised.

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