Larry, I'm reading "Trade Your Way to Financial Freedom". I'm in the chapter about Expectancy. I thought about calculating the Expectancy of the COT as a system. Would this be possible?

Cory,

It is not only possible, it is a great idea. Let's look at the expectancy folmula...

Expectancy = (PW*AW) less (PL*AL)

PW = Probablility of a winning trade
AW = The average gain
PL = Probability of a losing trade
AL = The average loss

If you will review SMR Issues 12 and 13, I gave an overview of several approaches, and I gave, according to my data, the percentage wins, percentage losses, average gain, and average loss of the various approaches. But please do your own homework. My figures may be off. If you need to know where to get the information to do so, let me know and I'll point you in the right direction.

Larry

Using the 51%-49% in conjunction with the Buy Weakness and Sell Strength, I got the following data from your report:
26 trades: 23 profitable, 3 unprofitable
PW = 88.5%
PL = 11.5%

The report states Average Winning Trade = 17.41%
Average Losing Trade = 4.26%
Therefore,
Expectancy=(88.5% * $1.1741) - (11.5% * $1.0426)
1.04 - .12
= .92

Is this correct? If so, it would mean an average gain of .92 per dollar risked?

Cory, it looks right to me. I'm not sure that only 26 trades is enough to be very meaningful. But to the extent that it is meanigful, it means that, on average, for every dollar that you risk you would expect to get back 92 cents. So you get your dollar back plus 92 cents. Of course, it doesn't mean that you will win every time. But, theoretically, you would win 88.5% of the time.

So supposedly since you'll make on average 92 cents for every dollar risked, if you risk $1,000 on every trade, you would make $92,000 over 100 trades.

But I think you really have to examine each trade in detail. For example, there were three losses. One of those losses was about 12% as I recall. The other two were extremely small, 1% or less. So to say that the average loss was 4.26%, I'm not sure tells us very much in terms of what to expect in the future.

As Tharp says, you use expectancy to compare one system with another. Also, as he says, it doesn't tell you whether you will be able to make money at it. He says that depends on your money management, or what he calls "position sizing." By the way, I think the chapter on position sizing is the most important one in the book.

Larry