How to calculate and use payoff ratio

elitetradesman · Apr 17, 2011

My book says the payoff ratio is "Average winning trade dollar amount divided by the average losing trade dollar amount".

So if you have 10 winning trades resulting in a gross profit of $3000 and 2 losing trades resulting in a gross loss of $1000, then I'd get the payoff ratio:

(3000 / 10) / (1000 / 2) = 0.6

Is this correct?

If so, then many winning trades with a smaller average profit and just a few losing trades with a larger average loss will give you a small payoff ratio. On the other hand, a few winning trades with a larger average profit and many losing trades with a smaller average loss will give you a big payoff ratio. Then, you could have a losing system with a big payoff ratio, and vice-versa.

How do you interpret and utilize the payoff ratio?

intradaybill · Apr 18, 2011

Quote from elitetradesman:

My book says the payoff ratio is "Average winning trade dollar amount divided by the average losing trade dollar amount".

So if you have 10 winning trades resulting in a gross profit of $3000 and 2 losing trades resulting in a gross loss of $1000, then I'd get the payoff ratio:

(3000 / 10) / (1000 / 2) = 0.6

Is this correct?

I looks correct.

Quote from elitetradesman:

If so, then many winning trades with a smaller average profit and just a few losing trades with a larger average loss will give you a small payoff ratio. On the other hand, a few winning trades with a larger average profit and many losing trades with a smaller average loss will give you a big payoff ratio. Then, you could have a losing system with a big payoff ratio, and vice-versa.

How do you interpret and utilize the payoff ratio?

Some answers are here where the authors derives the formula that relates win rate, profit factor and payoff ratio:

http://www.priceactionlab.com/Literature/profitability.pdf

Basically, the formula is: w = pf/(pf+R)

where pf = profit factor, R = payoff ratio and w is the win rate.

elitetradesman · Apr 18, 2011

Quote from intradaybill:

I looks correct.

Some answers are here where the authors derives the formula that relates win rate, profit factor and payoff ratio:

http://www.priceactionlab.com/Literature/profitability.pdf

Basically, the formula is: w = pf/(pf+R)

where pf = profit factor, R = payoff ratio and w is the win rate.

Thanks, I thought the win rate was the same as the winning percentage all this time.

can I take it that the payoff ratio can't be used alone?

intradaybill · Apr 18, 2011

Quote from elitetradesman:

Thanks, I thought the win rate was the same as the winning percentage all this time.

It is.

Quote from elitetradesman:

can I take it that the payoff ratio can't be used alone?

It says little overall. A payoff ratio of 2 is not good enough if the system has a win rate less than 33.3%.

On the other hand, a payoff ratio of 0.5 is good enough if the win rate is more than 67.7%.

You should read that paper. It is a must read for all traders. Simple formula but it conveys important information about the viability of trading systems in general in different time frames.