A Trading Edge – What does this mean?
“A trading edge.” This is a widely used, but mostly misunderstood concept in trading. This is the topic for discussion in this week’s Factor Update.
A trading edge is the thin advantage gained over the markets by one’s trading practices. The concept of trading edge is much more pertinent to the futures and forex markets than to the equity markets because futures and forex trading are zero sum games (actually, less than zero sum games because of trading fees). In the equity markets, most everyone gains from a general bull trend except for a small short interest – and short interest players can even be right at the expense of shareholders. In futures and forex there is a short for every long. I can only make money in futures if someone else loses money. Worded a different way, I must be a skilled pick-pocket in order to profit from my trading.
Newcomers to futures and forex trading often falsely believe a large edge can be gained through the selection of the market to trade and the day and price of entry – something I refer to as “trade selection” or “trade identification.” In reality, trade selection offers very little in the way of a trading edge, contrary to popular belief or the ads by the con artists claiming such things as “Right 72% of the time,” or “28% return in just four weeks.”
I trade classical chart configurations, with a focus on:
· Head and shoulders patterns, rectangles and right angled triangles (minimizing such patterns as symmetrical triangles, wedges and trendlines)
· Chart configurations at least 12 or so weeks in duration
· Measured move targets equal to approximately $3,000 per futures contract (or per a forex position with a USD value of $100,000)
Do the chart patterns I attempt to identify give me an edge in trading? Yes, but only a slight edge, and then only to the degree I remain extremely disciplined and patient and apply rigorous risk management protocols.
The real edge in my trading comes in three ways:
1. Getting out of a losing trade quickly and allowing a winning trade to grow in value. In other words, how and when I exit a trade is far more important than how and when I enter a trade.
2. Remaining in trades for days, weeks or even months
3. Increasing my bet size two or three fold on a very small proportion of trades (less than five per year) and being right on a few of the trades I parlay.
I need to comment further on #2 above. My observation is that most novice traders pursue day trading. For the life of me I cannot understand this decision. The HFT operations own the bid/offer spread (often an artificially expanded bid/offer spread) – thereby gaining the most significant edge within a trading day.
This fact places an unusual burden on novice day traders to actually find an edge that works.
To summarize:
· Classical charting principles only offer an edge to the extent patience, discipline and aggressive risk management is used in a trading operation
· The real edge comes from selectively increasing leverage, from jettisoning losers quickly and from holding onto winning trades.
“A trading edge.” This is a widely used, but mostly misunderstood concept in trading. This is the topic for discussion in this week’s Factor Update.
A trading edge is the thin advantage gained over the markets by one’s trading practices. The concept of trading edge is much more pertinent to the futures and forex markets than to the equity markets because futures and forex trading are zero sum games (actually, less than zero sum games because of trading fees). In the equity markets, most everyone gains from a general bull trend except for a small short interest – and short interest players can even be right at the expense of shareholders. In futures and forex there is a short for every long. I can only make money in futures if someone else loses money. Worded a different way, I must be a skilled pick-pocket in order to profit from my trading.
Newcomers to futures and forex trading often falsely believe a large edge can be gained through the selection of the market to trade and the day and price of entry – something I refer to as “trade selection” or “trade identification.” In reality, trade selection offers very little in the way of a trading edge, contrary to popular belief or the ads by the con artists claiming such things as “Right 72% of the time,” or “28% return in just four weeks.”
I trade classical chart configurations, with a focus on:
· Head and shoulders patterns, rectangles and right angled triangles (minimizing such patterns as symmetrical triangles, wedges and trendlines)
· Chart configurations at least 12 or so weeks in duration
· Measured move targets equal to approximately $3,000 per futures contract (or per a forex position with a USD value of $100,000)
Do the chart patterns I attempt to identify give me an edge in trading? Yes, but only a slight edge, and then only to the degree I remain extremely disciplined and patient and apply rigorous risk management protocols.
The real edge in my trading comes in three ways:
1. Getting out of a losing trade quickly and allowing a winning trade to grow in value. In other words, how and when I exit a trade is far more important than how and when I enter a trade.
2. Remaining in trades for days, weeks or even months
3. Increasing my bet size two or three fold on a very small proportion of trades (less than five per year) and being right on a few of the trades I parlay.
I need to comment further on #2 above. My observation is that most novice traders pursue day trading. For the life of me I cannot understand this decision. The HFT operations own the bid/offer spread (often an artificially expanded bid/offer spread) – thereby gaining the most significant edge within a trading day.
This fact places an unusual burden on novice day traders to actually find an edge that works.
To summarize:
· Classical charting principles only offer an edge to the extent patience, discipline and aggressive risk management is used in a trading operation
· The real edge comes from selectively increasing leverage, from jettisoning losers quickly and from holding onto winning trades.
Master Your Setup, Master Your self. (NQoos)