Definition
A measure of a trade’s potential reward relative to its risk. It helps traders assess the risk-reward profile of potential trades.
Formula
Expectancy = Profit Target / (Average Entry Price – Risk)
- Profit Target: The price you aim to exit the trade with a profit.
- Average Entry Price: The average price at which you enter the trade.
- Risk: The amount you are willing to risk per trade (often determined by stop-loss placement).
Example
Let’s say you have the following trade setup:
- Profit Target: $1.50 above entry
- Average Entry Price: $10.00
- Risk: $0.50
Your Expectancy would be: $1.50 / ($10.00 – $0.50) = 0.16
This means, for every dollar you risk, you have the potential to gain $0.16.
Key Points
- Risk-Reward Assessment: A higher Expectancy indicates a more favorable risk-reward ratio.
- Trade Selection: Can be used to compare potential trades and prioritize those with better Expectancy values.
Considerations
- Realistic Targets: Setting achievable profit targets is crucial for accurate Expectancy calculations.
- This Definition: It’s important to remember that this is one way to calculate and interpret Expectancy.
