Below is the post of ST da regarding the expectancy of trade system.......
EXPECTANCY OF TRADING METHOD :
The traders have a misconception that if they follow any method /system they will make money....nothing is further from truth. They will make money only if the method has positive expectancy...if it has negative expectancy, traders if they trade that system , they will loose "systematically"
Let us see what this expectancy is and how we can find out expectancy of the method we trade. I will explain the concept in practical terms and also give example of a real trading method, its parameters and how to find expectancy of this method.
The expectancy is the amount you’ll make on the average on every trade per rupee risked on your trading method . Expectancy can be mathematically expressed as :
Expectancy = ( Probability of win X Average win ) - ( Probability of loss x average loss )
In our MM game posted some posts earlier, we had our winners making 2 times our loosers and we had 20 winning and 20 loosing trades so the probability of win/loss both are 50 % or 0.5 So let us solve this equation :
E = ( 0.5 X 2) - ( 0.5 X1)
= 1- 0.5
= 0.5
This expextancy is a positive figure....so the method will make money...and it will make more money if we take more trades on the same.
But if the loosers were two times the winners......then this equation will give expectancy as -0.5 ......so that method will loose money no matter how faithfully you follow it......
Readers can get more information about expectancy in a fine book titled "
'Trade Your Way to Financial Freedom’ by Dr. Van K Tharp
The method will have more expectancy if it has either higher hit rate ie higher percentage of winners or higher average amount made on a winning trade....this is where importance of staying with your winning trades ,adding to your winners and cutting your loosers early comes into play.....
In next post we will apply this concept to a real swing trade method, list the method parameters to understand the expectancy of the method based on actual trades generated by the method ......
Smart_trade