Positive Expectancy and Opportunities

Positive Expectancy

A methodology must be able to deliver a probable positive expectancy. Expectancy is made up of accuracy and payoff. Improving the accuracy and the average win-to-average loss payoff are important tools to reduce our risk of ruin. To calculate methodology expectancy, we can use the following formula (Penfold, 2010).


For example, if your probability of winning is 35%, your average winning trade profits $10, and your average losing trade loses -$3, this trading system has a positive expectancy because over the long-term, it should yield an average profit of $1.55 per trade.

In contrast, consider a trading system that wins 90% of the time gaining $1 on average but loses $20 on average on the 10% of losing trades, this trading system is worthless despite its 90% success rate because it has a negative expectancy (-$1.10). An example of such a losing system is selling deep out-of-the-money call options. You win most of the time but the few times you lose destroy your trading account.


Opportunities simply refer to the number of times you can apply to your expectancy. You can have a methodology with the highest expectancy, but unless you get opportunities to trade it, there will be little reward. Trading extra markets and multiple timeframes are common ways to increase opportunities. However, both ways are only sensible if your account can afford the extra margin requirements and you are comfortable with the potential extra drawdowns.


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