Formulas Used in the Stock Market to Calculate the Profit of a Trade

Formulas help to quantify your results in stock trading.

Most investors participate in the stock market for the purpose of making money. Typically, you buy a stock with the hope it will rise in value. However, there are many ways to calculate not just the profit of a single trade but also the overall profit or loss of a trading strategy. These formulas are critical to understanding your trading success.

Percentage returns

You often measure investment returns in percentages. This is true not just with stock market investing but any form of financial transaction that yields an investment return. For example, savings accounts or certificates of deposit measure their interest returns as an annual percentage. In the stock market, calculations may yield percentage returns as well. A simple formula determines the percentage returns of a stock position. The percent increase or decrease is current value of the share price minus the purchase value, divided by the original purchase price. For example, a stock that you bought for $20 per share is now trading at $23 per share. The percentage return is (23-20)/20, which equals 0.15, or 15%. This is a simple formula for estimating overall profit or loss, but it does not take into account other factors, such as commissions, and also does not quantify the profit of many trades using the same strategy.

Cost basis

Most brokerage platforms note your investment in a certain stock as a "cost basis." This is usually similar to the purchase price of the stock, but it's never exactly the same. The cost basis formula incorporates commissions into the calculation. You then divide the total commission cost of the trade by the number of shares purchased. This amount is added to the purchase price of the share. For example, if you purchase 100 shares of $20 stock and the commission charge for the entire transaction is $9, then your cost basis (per share) is (9/100)+20, which equals $20.09. This provides a more accurate picture of the trade's profit when comparing the cost basis to the current share price.

If the stock splits while you hold it, the cost basis reflects this as well. The number of shares in your position doubles while the original share price is cut in half. In this case, the same formula yields (9/200)+10, or a cost basis of $10.05.

Expectancy

"Expectancy" determines the profit of a trading strategy. First calculate the percentage returns of all your trades. Divide the trades into winning and losing groups and average each group. To average, simply add them together and divide by the number of summed parts. Then divide the number of trades with positive returns by the total number trades. This is the percentage of trades that performed well. Subtract this number from 1, and this includes all the trades with negative returns. The expectancy formula multiples the average percentage return of your positive trades with the percentage of trades that were positive, then subtracts this same multiplication between the negative trades. For example, if you make three trades and the returns are 2%, 11% and -8%, then the average winning trade is (2+11)/2, or 6.5%, and the average losing trade is -8%, since there is only one. The expectancy is 6.5*.66-.8*.33, which is 1.65. This means that you can expect future trades to return, on average, 1.65%. Professional traders use expectancy to assess their performance.

References

• Swing Trading Options: Profit and Loss Calculations
• Investopedia: How do I figure out my cost basis on a stock investment?
• Trader Mike: Trading 101: Expectancy