Thursday 11 November 2010

Expectancy Revisit

Had a chat with fellow trader today and prompt me to take a look back at my earlier blog on EXPECTANCY.
Expectancy = (Probability of Win * Average Win) - (Probability of Loss * Average Loss)
We can look at it in another way, as a ratio between accuracy and risk reward.
Expectancy = Accuracy * Risk Reward
Lets say we've an accuracy of 40%, i.e we're correct 4 out of 10 trades; and we've a risk reward of 3, i.e target is 3 times that of stop loss. We'll get this.
Expectancy = 4/10 * 3 = 1.2 (positive)
To break even, i.e. Expectancy of 1. Risk Reward has to be greater then 1/Accuracy
Risk Reward > 1/Accuracy
For above example, for accuracy of 40%, RR need to be greater then 1/(40%) or 10/4 or 2.5
Minimum Risk Reward needed for various Accuracy is as follow
Accuracy - Risk Reward
10% - 10.000
20% - 05.000
30% - 03.333
40% - 02.500
50% - 02.000
60% - 01.666
70% - 01.428
80% - 01.250
90% - 01.111