Trading expectations and volatility

Expectancy requires a trading strategy

One of the benefits of calculating trading expectancy is that it forces you to define a strategy. The strategy goes well beyond the number of trades that you expect to win or lose. You need to specifically define your risk management and stick to the plan to reach your trade expectancy.

Regardless if you are planning to use an automated strategy or a discretionary strategy, you need to plot out how much you plan to win on average on each trade, and how much you expect to lose on each trade.

The best strategies start with determining risk. Once you decide the most you are willing to lose on a trade or strategy, you can then work out how much you need to make to generate a successful trading strategy.

Evaluate the largest drawdown

When you look at trading expectancy, you evaluate the average win and average loss per trade. One problem with only evaluating these metrics is that you could miss the elephant in the room. The average loss per trade could be littered with many small losses and one or two very large losses. If your expectations are based on average losses, and the first two losses you face are outsized losses, your ability to continue to execute the strategy could be curtailed. Make sure you measure the largest loss relative to the average loss before you start executing a strategy.

Summary

Your trading expectancy evaluates whether a strategy will be a winner or a loser. You need to make some assumptions about the average win or average loss when determining your trading expectancy. You want to measure trading expectancy over time and evaluate the largest loss before you begin to execute a trading strategy.