Expectancy: the number that says whether you have an edge

Ask traders how good their strategy is and most quote a win rate. A 70% win rate sounds better than a 35% one, but on its own it says almost nothing about whether the strategy makes money.

Win rate and payoff together

A strategy that wins 70% of the time but loses ₹3 for every ₹1 it wins is a slow way to lose money. One that wins 35% of the time but makes ₹3 for every ₹1 it loses is a good strategy. What matters is how often you win and how much a win is worth next to a loss, taken together.

Expectancy = win rate × average win − loss rate × average loss

Measured in R, where 1R is the amount risked on a trade, the 35% strategy above is worth 0.35 × 3 − 0.65 × 1 = +0.40R a trade. Risking ₹5,000 a trade, that is ₹2,000 on an average trade, before costs.

Working it out from your own trades

Take a list of closed trades. Add up the profit of the winners and divide by their number to get the average win. Do the same for the losers. Your win rate is the number of winners over the total. If you sized from your stops, divide each result by the amount risked to get R. If not, use rupees. The trade journal analyser does this from a Zerodha tradebook, after charges.

How luck hides an edge

Expectancy is an average over many trades. Over twenty trades, a positive edge can show a loss, and a losing strategy can show a profit. Even over a hundred trades, the same rules can end far apart depending on the order the wins and losses arrive in. The strategy odds simulator plays your numbers out a thousand times to show that spread, along with the drawdowns and losing streaks you should expect on the way.

Low win rates are normal for trend followers

Breakout and trend strategies often win only a third of their trades or fewer, because they cut losers early and let the occasional winner run for many times the risk. That makes them hard to trade by feel, because long strings of small losses come before the few large wins. Knowing the expectancy, and the losing streaks it implies, lets you keep taking the trades.