A most important formula for our trading is the Expectancy Formula. Its basic formulation is in dollars terms.
(Average Dollar Win/Win Rate) – (Average Dollar Loss/Loss Rate) = Expected Profit per Trade
- My AVG$win is $750.00
- My Win rate is 48%
- My Avg$ loss is $183
- My Loss rate is 52%
- My avg trades per year is 300
My expected $ profit would be:
$((750 x .48) – $(183 x .52)) x 300 =
$(360 – 95) x 300) = $79452
The interesting thing is when using the formula in this way I seldom came close to the actual profit. I looked into the problem and found that the reason lay with the mix of instruments. If the mix remained the same, then the formula would come close to the actual results; but most times, my mix altered and when that happened, the results skewed.
It’s not hard to see why: a $300 profit in Oats is not the same as a $300 profit in the EUUS given the different volatilty of the two instruments.
I knew that if I wanted to take the formula to the next level, I had to find a way of normalizing the results across instruments. I chose to normalize the results by reference to the open on a one contract basis:
(close price of the trade – open price of the trade)/close price of the trade = % of open price of the trade
Thus I am now able to compare apples with apples. By doing it this way, I am able to anticipate more accurately the return per trade.