|
|
|
|
|
|
|
their money. An experienced trader uses a mathematical formula to examine how risk and profit relate and to calculate the expected outcome of a trade. This is important because a trader must focus on the combined picture of profit and loss. By thinking about how a particular trade might work out, the trader is increasing the probability of ultimate success. The mathematical formula for the expected outcome of any particular trade is simply the sum of the chances of each element of that trade occurring. The formula is: |
|
|
|
|
|
|
|
|
where a = chance of trade event occurring |
|
|
|
|
|
|
|
|
n = total number of trades |
|
|
|
|
|
|
|
|
i = period when event occurred |
|
|
|
|
|
|
|
|
While it looks like a complicated formula, it really is not. In order to determine what the expected outcome of two trades will be, the trader must determine the percentage of winning to losing trades, the amount of average profits, and the average loss. For example, a trader who makes $100 on average for every winning trade and loses $50 on average on every losing trade is 50 percent profitable (hence 50 percent of the time the trader loses). Then we can plug the numbers into the formula and determine the expected profits after two trades. |
|
|
|
|
|
|
|
|
Using another example, if a trader makes $75 on average for every winning trade, loses $50 on every losing trade, and is profitable 60 percent of the time (loses 40 percent of the time), then the expected profit after two trades is: |
|
|
|
|
|
|
|
|
One last example. A trader makes $100 on winning trades, loses $50 on losing trades, and loses 60 percent of the time (winning 40 percent). The expected profit after two trades is: |
|
|
|
|
|
