Understanding the Concept: What is Expected Return?
The term Expected Return refers to the potential profit or loss an investor anticipates on an investment relative to the amount invested. It's a key element in financial and trading theory, helping traders to predict future earnings.
Diving Deeper Into Expected Return
In the world of trading, the Expected Return is theorized on the basis of historical data, probability distributions, and calculated risk. It is an average of all possible returns, each of which is weighed against the likelihood of the return occurring. In simple terms, the Expected Return is what you anticipate to either gain or lose from your investment over time.
How Can Investors Calculate Expected Return?
There's a standard formula to work out the Expected Return of an investment. You multiply the probabilities of each possible outcome by the potential returns of each, and then sum these figures. The formula is as follows: E(R) = Σ [pi * Ri], where pi represents the probability of each return and Ri represents each possible return.
The Role of Expected Return in Trading
The Expected Return plays a big role in trading. It helps investors make key decisions regarding potential investments. For instance, if an investment shows a high Expected Return, it might be considered as a viable option for investment. However, it's also important to consider the risk associated with that return.
Risks and Expected Return
When calculating the Expected Return, one must also take into account the associated risk. In trading, the Expected Return and risk go hand in hand. Typically, investments with a higher Expected Return come with a higher degree of risk. Therefore, as an investor, it's essential to balance your desire for high returns with your ability to tolerate risk.
