Average favourable excursion divided by average adverse excursion, both volatility-normalised, measuring whether an entry signal has any predictive power at all.
Take every signal, measure the maximum favourable and maximum adverse excursion over a fixed horizon, normalise both by atr at entry, and divide the averages. A value above 1 means price tends to move in the signal's favour more than against it; a value at 1 means the entry is noise.
Its virtue is isolation. The e-ratio tests the entry alone, with no exit rules, no position sizing and no discretion, so a signal can be evaluated before any of the parameters that make backtests untrustworthy get involved. Plot it across horizons - 5, 10, 20, 50 bars - and you also see how long the edge persists, which is direct evidence for choosing a holding period.
Most popular entry patterns score close to 1.0 under this test. That is the point of running it: it fails cheap ideas quickly, before they are dressed up in exits that hide the absence of an edge.
Original diagrams for the ideas on this page. Illustrative, not real market data.
Expectancy: the average trade. Forty trades sorted by outcome: 24 small losses and 16 larger wins. Weighting each side by how often it happens gives the average result per trade, marked here by the dashed line at +$120.Working out a position size. Three numbers decide how big a trade is: the account, the share of it put at risk, and the distance from entry to stop. One percent of $25,000 is a $250 budget, and a $0.50 stop divides into that 500 times.
Educational only, not advice. Spotted an error? Post in Site Feedback.