Profit/Loss Ratio

What Is the Profit/Loss Ratio?

The profit/loss ratio acts like a scorecard for an active trader whose primary motive is to boost trading gains. The profit/loss ratio is the average profit on winning trades partitioned by the average loss on losing trades throughout a predetermined time span.
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Profit/Loss Ratio Explained

The profit/loss ratio measures how a trading strategy or system is performing. Clearly, the higher the ratio the better. Many trading books call for essentially a 2:1 ratio. For instance, in the event that a system had a triumphant average of $750 per trade and an average loss throughout a similar season of $250 per trade, then the profit/loss ratio would be 3:1. A reliably strong profit/loss ratio can urge a trader to leverage wagers on a similar strategy trying to create greater absolute profits. On the other hand, an unsuitable profit/loss ratio would lead to an examination of the strategy or system employed to track down weak connections. Maybe the trader will choose to abandon a strategy or system through and through in the event that the ratio isn't delivering adequate gains or even causing capital losses.

Thinking Beyond the Ratio

The profit/loss ratio can be an excessively oversimplified perspective on in light of the fact that it neglects to consider the probabilities of gains or losses for the trades. A concept called average profitability per trade (APPT) can be more clever. APPT is the average amount a trader can hope to win or lose per trade. APPT is the difference between a) the product of the likelihood of win and average win; and b) the product of the likelihood of loss and average loss. For instance, take 10 trades, three of which were profitable and seven were losing. The success likelihood, accordingly, is 30% and loss likelihood is 70%. Further, accept that the average winning trade was $600 and the average losing trade was $300. APPT is (30% x $600) less (70% x 300), or - $30. Hence, even however the profit/loss ratio was 2:1 ($600:$300), the trading strategy is really a losing one in terms of likelihood.