24 / 08 / 29

Forget Accuracy: Why Positive Expectancy Is Your New Trading Superpower

Be it any style of investing or trading

Growth , value , large cap , small cap , Dividend etc

Day trading, swing trading, systematic trading etc

the math behind profits is simple and same.

All profitable styles of investing/trading share one key factor: positive expectancy.

Understanding positive expectancy will help you optimize your behaviour to chase the right metrics.

Prior to understanding positive expectancy, unknowingly my behaviour was chasing the wrong metric - Accuracy. And it is a counterproductive metric to chase as well. Chasing accuracy harms your portfolio.

If you are a beginner investor or trader, you might have experienced this.

You feel good when you book a profit and you feel bad when a trade turns into a loss.

This feeling says that we are chasing accuracy. But what really matters is "POSITIVE EXPECTANCY".

Let me explain.

What is positive expectancy?

It is easier to explain with a simple example.

  • Imagine you flip a coin 100 times.

  • If heads, you win $2, tails you lose $1.

  • Though you might lose sometimes, over a large number of flips, you're expected to win more money than you lose.

  • Because you make more when you are right ( $2) and when you wrong you lose less ($1)

Expectancy = (Win Percentage x Average Win) - (Loss Percentage x Average Loss)

Let's say your style of trading

  • Win Percentage = 30% that is you out of 10 trades, you are right only 3 times.

  • Average Win = $500

  • Loss Percentage = 70%

  • Average Loss = $100

  • Expectancy = (0.3 x 500) - (0.7 x 100) = 150 - 70 = 80

This strategy has a positive expectancy of $80 per trade, meaning that over a large number of trades, your strategy though it gets only 3 out of 10 trades right, is still expected to fetch you $80

What can we learn from this positive expectancy?

  1. Accuracy is not the right metric to optimize our behaviour for: I deliberately chose an example with 30% win percentage to show that accuracy is not right. Chasing accuracy can be counterproductive as well. As limiting gains (selling winners early - chasing accuracy behavior ) and maximizing losses ( holding on to losers - refusing to take a loss - chasing accuracy behavior) does the exact opposite. so what matters?

  2. Maximize winners and limit losers: Making more on the winning trades and losing less on the losing trades is all that matters to be profitable.

  3. Law of Large numbers: It is not about getting every trade right. It's about how much you make on "an average" over a large number of trades.

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