Big Mike's Trading Blog

Day trading futures, discussing money management and trade management techniques, and more

Van Tharp's Max Expectancy and System Quality Number (SQN)

caprica on the BMT forums has started some discussions on Van Tharp's Max Expectancy and Van Tharp's System Quality Number (SQN).  I was only vaguely familiar with these principles, so I've learned alot in the last few days.

The principals behind the two formulas is interesting, but I am a meat and potatoes kinda guy so I skimmed that do get a basic understanding and then moved straight to the download so I can add this to NinjaTrader.  caprica posted two downloads which are NinjaTrader Optimizer Types, so basically now instead of optimizing on Net Profit you can optimize on Max Expectancy or SQN.

I ran some of my system strategies through the new optimizer types, and was quite shocked.  When you combine these new optimizer types with piersh's genetic optimizer, you really can elevate your strategy backtesting to all new heights.

Here is the thread on Max Expectancy:

Here is the thread on System Quality Number:

The link to the downloads for NinjaTrader is included in the thread.  I also highly recommend checking out the other Psychology and Money Management threads on the BMT forum, there are some more discussions about Van Tharp's Position Sizing and several new discussions on risk management.  I'm learning a lot each day from fellow traders who have come far enough along in their trading journey to pay the proper attention to money management and psychology.

Quoting caprica, here is a quick definition of Max Expectancy:
So what is expectancy?

Expectancy is your profit percentage per win multiplied by your win rate minus your loss percentage per loss multiplied by your loss rate.

Expectancy tells you what you can expect to make (win or lose) for every dollar risked. Casinos make money because the expectancy of every one of their games is in their favor. Play long enough and you are expected to lose and they are expected to win because the “odds” are in their favor.

Example, you could have 99 losing trades, each costing you a dollar. Thus, you would be down $99. However, if you had one winning trade of $500, then you would have a net payoff of $401 ($500 less $99)—despite the fact that only one of your trades was a winner and 99% of your trades were losers.

And again quoting caprica, here is a quote on System Quality Number:

The only way to seriously qualify and optimize any system is through its System Quality Number (SQN). I advice you to refer to Van Tharp for reference on the subject.

Assuming a set of N trades (N>30 for being statistically significant), SQN is defined as follow:

SQN= Squareroot(N) * Average (of the N Profit&Loss) / Std dev (of the N Profit&Loss).

The large the N, the more trading opportunities you have.
The large the average P&L, the better you are obviously.
The smaller the Std dev (P&L), the more regular are your results and the smaller are the drawdowns.

Note here that if you optimize for the largest SQN, you maximize in fact the product N*average P&L and you minimize the Std dev (P&L) and the drawdowns at the same time.

This is exactly what all good traders should be looking for their system.




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