Expectancy is suggested to be an even more important metric than accuracy to evaluate your trading performance. I see it a bit like a contractor’s day rate – the pay per unit of invested time with effort and experience being factored into the charge. Only that expectancy denotes your pay per trade with invested time and effort being rewarded (or not), and it is more of an average rather than a guaranteed amount per unit.
First up, here is the formula to calculate trading expectancy, which I discovered through the free newsletter series “Seven Steps to Systems Success” by SMB.
The formula basically says that if you followed your trading method rigorously, you should expect to make the calculated sum over time per trade; $260 per trade in the example above. Now, that doesn’t mean that each trade will yield the expected value, but rather that the average of your trades over time should be that value. To get a meaningful expectancy value for your system, SMB say that you should base it on at least 100 trades. Once the value drops below that baseline, it suggests that the strategy no longer works all that well.
I thought it would be fun to track accuracy and expectancy with every trade to see how they evolve over time. Below are the charts for my two accounts.
Account 1 currently shows higher accuracy (i.e. how often I am right in predicting price movement) than Account 2 with roughly 50% vs. 35%. However, Account 1 has a negative expectancy at ca. -$10 as opposed to Account 2 with ca. +10$. This real example demonstrates that expectancy is indeed a good indicator of trading performance, maybe even more important than accuracy.
My problem here is that Account 1 is my real and Account 2 my paper account. Needless to say that the difference in expectancy is undeniably reflected in the P/L. Ouch! I have yet to analyse the differences between them in more detail to figure out what’s going on. Meanwhile I keep the chart of Account 1 coloured in green, apparently the colour of prosperity and growth. Sigh!
On a final note, it’s unsurprising that we tend to focus on accuracy as new traders because that type of thinking originates from natural instincts and is reinforced by the education system. School exams, for example, have pass grades somewhere above 50%. Anything below makes you a failure by numbers regardless of the quality of your correct answers. However, in trading you can be successful with an accuracy below 50%. Even if more than half of the trades go against you, you can be profitable provided the strategy is good enough, i.e. your winners exceed your losers (and fees).