Expectancy and Profit Factor

Expectancy

Expectancy equals win rate times average win minus loss rate times average loss. With a 40 percent win rate, average win 2R and average loss 1R: 0.4 times 2 minus 0.6 times 1 equals 0.2R. Each trade is worth a fifth of the risk taken on it, on average. At 100 dollars risk per trade and 20 trades a month, that is 400 dollars a month before costs, and the costs must then be subtracted: a 0.2R expectancy with 0.1R of spread per trade is really 0.1R.

Profit factor

Add up all the winning trades and divide by the sum of all the losing trades. 6,000 dollars of gross profit and 4,000 of gross loss gives 1.5. Profit factor and expectancy say the same thing in different units, and profit factor is the one most journaling software reports. Below 1 the strategy loses; between 1 and 1.3 it is marginal and costs may sink it; above 1.5 it is robust; above 3 it is probably a small sample or an overfit.

Using them

• Compare strategies and setups on expectancy per trade and profit factor, not on total profit, which depends on how many trades you took.
• Track them month by month; a falling profit factor is the earliest sign a strategy is deteriorating.
• Multiply expectancy by trade frequency to compare a slow high-expectancy strategy with a fast low-expectancy one.
• Always subtract costs, including slippage, before believing a figure.

Sample size again

An expectancy of 0.2R over 30 trades is within the noise of zero. Over 300 it is probably real. Report the sample size with the figure every time, and be suspicious of any strategy sold on results from a few dozen trades.

Key takeaways

• Expectancy is win rate times average win minus loss rate times average loss.
• Profit factor is gross profit over gross loss; 1.5 or more after costs is robust.
• Compare strategies on these, track them monthly, subtract costs.
• Report the sample size with every figure.