Expectancy formula/ Frequency Multiplier

Discussion in 'Risk Management' started by Lightningsmurf, Jun 9, 2002.

  1. Does anyone know the formula for expectancy?

    I'm trying to figure out which system would give better theoretical returns:

    System A: Has 60% probability, Average Gain is $500. Average Loss is $250. 10 trades per (unit of time).

    System B : Has 60% probability, Average Gain is $1000. Average loss is $500. Makes five trades per (unit of time).

    Would these two systems bear the same results?
  2. The results are the same, except system B saves you a couple of dollars on commissions.

    Put your average gain and average win in dollars/cents or points rather than absolute dollars. For example, for stocks, say average win is $2.75, average loss 80 cents, or 5.5 points win 2.25 points loss. Your trade sizing will determine the actual dollars won or lost.

    The formula would be:

    Average Trade = (Av Win * Probability Win) - ((Av loss * (1 - Probablility Win)

    Total Profit = Average Trade * Shares Traded * Trades per Period

    (to keep it simpler I've ignored commissions.)

  3. This is true but if execution costs are reasonable I might prefer system A anyway.

    Smaller loss size means less pain in freak losing streak, bigger dollar risk helps when winning but kills when losing. Higher trade rate also means occasional negative deviations fall back in line faster.

    p.s. why couldn't you just double your risk per trade on system A and make it instantly superior to system B? Risk per trade is pretty much your own personal choice until u run into size constraints:confused: :confused: :confused:
  4. I use a fixed % type money management system and was trying to determine whether there would be any benefit to doubling my risk exposure, provided I could double my returns. Despite the commission costs, I think I'll stick with my current system which is closer to System A.
    Thanks for the input!
  5. i'm curious, care to elaborate on your reasoning behind the matthew 5:29 signoff quote?
  6. Well, the first time I saw that particular quote in the bible (no, I'm not a bible freak) I thought to myself, he means: "cut your losses and preserve your capital!" I admit I was mighty impressed to learn that the Disciple Matthew was a trader.

    It just goes to show, when you got trading on the brain - you can read it into almost anything.

    Thanks for the feedback.
  7. 10-4, makes sense.

    p.s. nothin' wrong with bein' a bible freak, as you so colorfully put it- I happen to be one myself :eek: :D