My book says the payoff ratio is "Average winning trade dollar amount divided by the average losing trade dollar amount". So if you have 10 winning trades resulting in a gross profit of $3000 and 2 losing trades resulting in a gross loss of $1000, then I'd get the payoff ratio: (3000 / 10) / (1000 / 2) = 0.6 Is this correct? If so, then many winning trades with a smaller average profit and just a few losing trades with a larger average loss will give you a small payoff ratio. On the other hand, a few winning trades with a larger average profit and many losing trades with a smaller average loss will give you a big payoff ratio. Then, you could have a losing system with a big payoff ratio, and vice-versa. How do you interpret and utilize the payoff ratio?
I looks correct. Some answers are here where the authors derives the formula that relates win rate, profit factor and payoff ratio: http://www.priceactionlab.com/Literature/profitability.pdf Basically, the formula is: w = pf/(pf+R) where pf = profit factor, R = payoff ratio and w is the win rate.
Thanks, I thought the win rate was the same as the winning percentage all this time. can I take it that the payoff ratio can't be used alone?
It is. It says little overall. A payoff ratio of 2 is not good enough if the system has a win rate less than 33.3%. On the other hand, a payoff ratio of 0.5 is good enough if the win rate is more than 67.7%. You should read that paper. It is a must read for all traders. Simple formula but it conveys important information about the viability of trading systems in general in different time frames.