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The Van Tharp Expectancy Metric | Estimate Trading Strategy Returns

The Van Tharp Expectancy concept builds on the original idea of R-Value/Multiples. It uses the fixed percentage risk model to forecast returns. The Van Tharp Expectancy concept can also be used as a metric to assess parameters when optimising a trading strategy.

To recap from last time

  • R-value – The initial risk taken in a position, as defined by the stop loss level.
  • R-Multiple – The return expressed as a multiple of the risk. A trade that returns 100 pips and had an SL of 50 pips is equal to 2R (100/50=2R)

How do we use The Van Tharp Expectancy concept to forecast returns?

To calculate the Expectancy of a trading strategy, you need to calculate the average R of the trading strategy you wish to use. 

Let’s assume a trading strategy that has the following returns distribution.

2R, 2R, 2R, 2R, 2R, 2R, 2R, 2R, -1R, -1R 

The total R of the strategy (ten trades) is 14R. 

The Expectancy of the strategy is 1.4R

What The Van Tharp Expectancy concept does is allow you to see the viability of a strategy quickly. You can focus your attention on systems that have a positive expectancy and backbench ones with a negative.

Or you can adapt the premise and use it to quickly ascertain which parameters have a positive or negative effect on the strategy as a whole. 

This flexibility makes this an ideal way to look at individual strategies, strategy parameters and even compare strategies. Talk about a multi-talented concept. As with everything in life, there are limitations. 

There are two critical pieces of information missing: the timeframe the Expectancy is measured over, the variability of returns. 

Time

If the above strategy returns were from one week of trading, the Expectancy of 1.4R would be every week. Assuming you traded 1% risk, that equals 1.4% per week, which is pretty darn good.

However, if the above example were the trading history over a year, the returns expectancy would only be 1.4% annually. Not so good when compared to a benchmark. 

Variability

Sadly forecasting returns isn’t an absolute business. There will inevitably be some variability in your realised returns from that of your Expectancy. 

Let’s add another example returning the same Expectancy of 1.4R into the mix. 

-1R, -1R, -1R, -1R, -1R, -1R, -1R, -1R, 11R, 11R

The total R of the strategy (ten trades) is 14R. 

The Expectancy of the strategy is 1.4R

What happens if each of the two examples has one less winning trade? 

Example 1

Total return = 11R

Expectancy = 1.1R

Example 2

Total return = 2R

Expectancy = 0.2R

Just one change in the distribution has a very different result in the two examples. This variability is where Van Tharps SQN concept comes in. To find out what this is, you’ll have to wait until the next episode, sorry.

But wait 

If, however, you can’t wait, there is another option. Darwinex created 12 proprietary metrics that enable traders and investors to judge the performance of a trading strategy or account. These metrics each aim to quantify the performance of a particular aspect of a trading account or DARWIN. 

The D-Score is Darwinex’s alternative to Van Tharps SQN. 

This proprietary metric provides a detailed overview of a trading strategies DARWIN and rates it between 0 & 100. This allows Investors to quickly judge whether to investigate a DARWIN further or move on to another. 

In fact, this metric is so helpful that Darwinex uses it when deciding how to allocate its capital in DarwinIA. The D-Score considers multiple factors to provide you with an easy to understand performance metric. You shouldn’t base your trading decisions based on a single metric, but you should definitely consider the D-Score.

Brought to you by Darwinex: UK FCA Regulated Broker, Asset Manager & Trader Exchange where Traders can legally attract Investor Capital and charge Performance Fees.

Risk disclosure:
https://www.darwinex.com/legal/risk-disclaimer


Content Disclaimer: The contents of this video (and all other videos by the presenter) are for educational purposes only, and are not to be construed as financial and/or investment advice.