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Many mathematical calculators have a summation function that will enable you to easily calculate the outcome after any number of trades. By sitting down one evening and playing with this formula, you will begin to understand how important it is to control your risk exposure, and how important it is to have an effective exit strategy that enables you to keep your profits. |
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By using this formula, you'll be able to obtain an indication of whether your methodology will be profitable in the future. Every successful trader has developed a methodology that yields a positive number. Unfortunately, most beginning traders have a negative expected outcome with their methodology. Using the expected outcome formula will help you look at the different possibilities and determine if your methodology is financially sound. |
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Return on Investment (ROI) |
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Professional traders measure their profitability through a fairly common mathematical formula: return on investment (ROI). The ROI tells us how effectively our capital was used over a period of 12 months. This is the most effective way to determine the performance of our methodology. Whereas beginning traders will measure success on how many winning trades they generate and the dollar amount generated, professional traders will use return on investment as a way to measure the profitability of his methodology. A trader can have 20 profitable trades in a row and return all the profits on the next trade. |
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For example, if a trader has a portfolio at the beginning of the year of $20,000, and by the end of the year has generated a profit of $8000, the rate of return is: |
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All traders experience a losing streak. The amount of money the trader loses over time from the previous equity high point is known as a drawdown. A drawdown represents the amount of money lost that must be replaced to return the equity back to the level it was at prior to the initial loss. When |
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