7 special trading formulas for all traders

Math may not be the strong point of many people. However, when it comes to speculating the global market as a trader, there are some formulas that one needs to know. This guide will show you some major trading formulas and how to apply them. The good part is; we have broken them down such that they are quite easy to understand, and their knowledge has huge benefits.

Let’s examine some of them:

1. Pip value formula

Pip value is the unit of measuring currency pair movement. The minimum pip can be seen in the fourth digit after the decimal place for major currency pairs within the exchange rate. Yen pairs hold an exception to this rule, with their minimum pip seen in the second digit right after the decimal place.

You can calculate the pip value for any underlying asset as follows:

Pip value = 1 pip ÷ the exchange rate x trade size.

—Derivation and example:

For the EUR/USD currency pair with an exchange rate of 1.2500 and trade (lot) size of 100,000:

Where One pip = 0.0001;

Pip value = 0.0001 ÷ 1.2 x 100,000 

= 8 EUR

2. Leverage formula

Leverage, concerning trading the foreign exchange market, positions the trader to take control of a large position by investing a small portion of their capital. In this case, the broker borrows the trader the rest of the money.

You can calculate your leverage using the below formula:

Leverage = trade (lot) size ÷ account size (trading capital)

—Derivation and example:

Assuming you plan on executing a trade with a lot size of 100,000 and a capital of $2,000, your leverage will be calculated as follows:

Leverage = USD 100,000 / USD 2,000 

= 50   ….In this case, you are trading with a 50:1 leverage.

3. Position size formula

The position size formula is vital for every trader to be aware of. Before diving into the market, you must calculate the position size concerning a preset sizing model.

Below is the math behind the position size formula:

Position size = current capital size x  Risk for each trade ÷  Distance between entry and stop loss x  Pip value.

—Derivation and example:

If you are trading with a risk of 2%, capital size of $10,000, the distance between entry and a stop loss of 80 pips, and pip value of $10.

The position size will be:

Position size = $10,000 x 0.02 ÷ 80 x 10 

=  0.25 Lots   …., In this case, the largest size of executed tease is .25 lots.

4. Trade expectancy formula

The trade expectancy formula is an important metric that a trader should not lack awareness about. Each trade’s average loss or profit is expected based on the average loss, trade volume, and percentage increase.

The trade expectancy formula is represented below:

Trade expectancy = ( percentage increase x Avg trade volume) – ( Loss percentage x Avg Loss Size)

—Derivation and example:

Having an average trade of $1,200, an increase percentage of 35%, and average losing trade of $400, The trade expectancy will be:

Trade expectancy = ( .35 x 1200) – ( .65 x 350)  

=  $192

5. Maximum drawdown formula

Losing trades are part of a trader’s success story. What is more important is to know the maximum drawdown of a particular trading strategy in identifying what is likely to happen in terms of future equity loss.

Here;

Max DD = Equity Peak – Equity Low / Equity Peak

—Derivation and example:

Let’s assume your starting capital is $10,000, which later adds up to $15,000. If your portfolio declines to $8,000 later on before ascending to $17,000, the maximum drawdown can be calculated as follows:

Maximum drawdown = $ 15,000 – $ 8,000 ÷ $ 15,000

= 46.6%

6. Risk of ruin formula

This formula shows the probability or likelihood that a trader will lose so much money that it will cause a discontinuation in the trade execution.

This formula can be calculated as shown below:

Risk of Ruin = [(1 – Edge) / (1 + Edge)] ^ capital units

Where “Edge” is the probability of a percentage increase.

7. Profit factor formula

The profit factor formula measures a trader’s potential profit from a strategy. 

It can be calculated using one of two ways:

1. Profit factor [method 1] = Gross trades / Gross losing trades
2. Profit factor [method 2]= (profit rate x Average increase) ÷ (Loss rate x Average loss)

—Derivation and example:

1. Profit factor < 1 implies a losing strategy.
2. The profit factor is between 1 and 1.5; it implies a moderate profit from a strategy.
3. The profit factor is between 1.5 and 2.0, which implies a very profitable strategy.
4. The profit factor is > 2, which implies an excessively profitable strategy.

Final notes

Understanding the various trading formulas and how to implement them in your daily trading activities can make all the difference.

Source:

—Investopedia terms listing; Investopedia: Financial terms—vocab

—Binomo glossary; blog.binomo-fin.com/glossary