WHAT IS POSITIVE EXPECTANCY?

WHAT IS POSITIVE EXPECTANCY?

“The expectancy is really the amount you’ll make on the average per dollar risked. If you have a methodology that makes you 50 cents or better per dollar risked, that’s superb. Most people don’t.”

~ Van Tharp

Note that the work below on expectancy and “R-multiples” is based on the original work of Van Tharp and is repeated here with his permission.

Expectancy is how much on average you are likely to make or lose when you place a trade in terms of your risk/reward ratio. An expectancy above zero means you have positive outcome.

For example, if you make on average $1.20 for every dollar you risk, then your expectation of profit would be 1.2 times your risk. In this case, you have an expectancy of 0.2 (positive). If you make .80 for every dollar you risk, then your profit would be 0.8 times your risk. In the second case, your expectancy would be -0.2 (negative).

You calculate your expectancy of your entire trading strategy by averaging the risk/reward over a series of trades, but before we get to the equation, it helps to understand what Tharp calls “R-multiples”.