Understanding Expected Value (EV)
Expected Value (EV) is a predicted value of a variable, calculated as the sum of all possible values each multiplied by the probability of its occurrence.
Why it matters
In finance and decision making, EV helps you determine if a risk is worth taking. A positive EV suggests that, over time, the decision should be profitable. A negative EV implies a loss in the long run.
The Formula
EV = (P₁ × V₁) + (P₂ × V₂) + ... + (Pₙ × Vₙ)
Example
Imagine a coin flip where Heads wins you $100 and Tails costs you $50. The EV is (0.50 × 100) + (0.50 × -50) = $50 - $25 = $25. Since the EV is positive ($25), it's a favorable bet to take repeatedly.