At this point I hope you are realizing that if you are going to be part of the elite, and are able to be consistently profitable year after year, there is much more to trading then simply finding a good way to enter the market.

Calculating your expectancy gives you a good idea of how much your system should make based on a given number of trades.  Expectancy is the return per dollar risked.  To be able to figure out your expectancy you also need to know a little bit about how your system performs.  This is the one advantage in buying a system vs building your own, if you are buying a credible system, generally you will also have the trade stats that the system has produced.  This data will be useful in determining just how well it will perform, and more importantly how well it performs vs another system.  After all, you have a limited amount of resources, you want to maximize your return on equity.  

Determining your systems expectancy allows you to see it's overall performance, but more importantly it creates a metric to compare systems against each other. 

This is the information needed about your system before you can calculate it's expectancy and evaluate it:

1. Winning %, also know as Reliability or Hit Rate
2. Cost of Trading, this includes things such as commissions, slippage, and any other per trade cost
3. Monthly Trade Opportunity, how many Valid trades will you be able to take in an average month
4. Size of Trading Capital, this is the entire trading account, not the amount to risk per trade
5. Position Size, how much of your capital are you risking per trade
6. Average Winning Trade, the average of all winning trades
7. Average Losing Trade, the average of all losing trades

The Calculation:

Expectancy = (Winning % x Average Winning Trade) - (Losing % x Average  Losing Trade)

Example:

1. Winning % = 42%
2. Cost of Trading = $12
3. Monthly Trade Opportunity =10
4. Size of Trading Capital = $20,000
5. Position Size = 2%
6. Average Winning Trade = $432
7. Average Losing Trade = $267

So my expectancy with the above data would be,   0.27 = (.42 x 432) - (.58 x 267)

You would then multiply your expectancy times your monthly trading opportunity times your $ amount risked to approximate monthly gains.  Then multiply your cost of trading times your monthly trade opportunity to get approx monthly expenses.  Subtract the two figures to come up with your ave. monthly return.  Again, if you don't want to do the math, download the calculator.

((0.27 x 10) x (400)) - (10 x 12) = 960

So in this example, with this system, your average monthly return should be $960.00

What does this mean?

This mean's that based on the systems performance, I should expect to make 27 cents per dollar risked.   So you now have a metric for comparing systems performance.  Keep in mind that you are evaluating past history and that means the greater number of trades that make up your systems data the more accurate it will be.

The Value of TIME

Now, the next thing you need to evaluate is what is the Monthly Trading Opportunity, in the above example our system makes an average of 10 trades per month.  What if you were comparing this system to another system that traded 20 times per month but only had an expectancy of 0.25 instead of 0.27, which would you choose?  I hope you took the 0.25 as it would put significantly more money in your account by the end of the year due to the fact that it is turning your money over much quicker.

I have found it much easier to incorporate everything involved into an estimated monthly return, that way after inputing all of the data, I can just select the system with the largest monthly return, all things being equal. 

To Fully Understand this Key Concept read Trade Your Way to Financial Freedom