In this article, We learn about “Expectation “.Let’s Go!
Expectation is an important concept in the trading world as it helps traders determine the potential profitability of a trading strategy over time.
By calculating expectations, traders can evaluate the effectiveness of their strategies and make informed decisions about whether to continue or adjust their approach.
Let’s explore the concept of anticipation, its importance in trading, and how to calculate it.
What is the expectation?
In trading, expectation is a statistical metric used to estimate the average amount of profit or loss per trade based on a trader’s historical performance.
It takes into account the Win rate (percentage of winning trades) and the Risk to reward ratio (the ratio of the average gain on winning trades to the average loss on losing trades).
Why are expectations important?
- Evaluate Trading Strategies: hopes to help traders evaluate the effectiveness of their trading strategies by quantifying their performance. Positive expectations indicate that the strategy will be profitable in the long run, while negative expectations indicate that the strategy may result in losses over time.
- Make informed decisions: By understanding the expectations of a trading strategy, a trader can make an informed decision on whether to continue using a particular method, adjust it, or explore alternative strategies.
- Managing Emotions: Expectations can help traders manage their emotions by providing a statistical basis for trading decisions. Understanding that a strategy has positive expectations can instill confidence in traders, allowing them to trade more objectively and with less emotional interference.
- Risk Management: Calculating expectations also aids in risk management as it allows traders to set appropriate position sizes based on their trading performance and risk tolerance.
How to Calculate Expected Value
To calculate expectations, you need to know the following information:
- Win Rate: The percentage of winning trades.
- Avg Profit: Average profit of winning trades.
- Average Loss: Average loss on losing trades.
Expected can be calculated using the following formula:
Expectation = (Win Rate x Average Win Rate) - ((1 - Win Rate) x Average Loss)
For example, let’s say a trader has a 60% win rate, an average profit of $100, and an average loss of $50.
Using the formula above, their expectation is:
Expected = (0.6 x $100) - ((1 - 0.6) x $50) Expected = $60 - $20 Expected = $40
This means that, over time, traders can make an average profit of $40 per trade.
Why Positive Expectations Matter
You may have heard two conflicting pieces of trading advice:
- “Take profits, you can’t go bankrupt!”
- “Cut your losses and let the winners run!”
So which one is correct?
Quick profits are possible… as long as the losses are not big
It is possible to let your profits run…as long as you keep your win rate high.
It all comes down to having positive expectations!
How to Raise Your Expectations
Traders can raise their expectations in a number of ways:
- Increase Win Rate: By perfecting their trading strategy and entry and exit criteria, traders can increase their win rate and thus their expectations.
- Improving the Risk-Reward Ratio: Traders can also focus on increasing the average gain on winning trades or minimizing the average loss on losing trades. This can be achieved through better risk management techniques, such as setting appropriate stop loss and take profit levels.
- Diversification: Diversified trading strategies and tools can help improve overall expectations by spreading risk across markets and reducing the impact of individual losing trades.
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