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# How to calculate and use payoff ratio

Discussion in 'Risk Management' started by elitetradesman, Apr 17, 2011.

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?