Today I would like to address a doubt that aspiring traders frequently have: how to obtain a trading edge. This question seems to appear especially when traders are exposed to various trading styles. In our System Development Workshop we expose traders to a variety of different trading styles – all utilized by successful traders. Each method exploits a different edge in the markets.
This is where many traders get confused and start asking:
- how many edges are there?
- how do I know I have an edge?
- how do I find an edge?
- is one edge more profitable than another?
What is an Edge
A trader’s edge is what defines his style and ultimately what differentiates his decision-making process from a coin-toss. It’s his material advantage. An edge derives from a series of observations that you have studied (hence, it is personal), that gives you a higher probability of a certain outcome. Essentially, you are making decisions based on something that is better than flipping a coin.
The first essential takeaway is that your trading edge will be personal. You need to observe, take note, study and verify. This is one of the reasons why teaching people how to trade is challenging: simply by passing along a set of rules, the aspiring trader will apply the rules blindly, without feeling. The trader instead needs to get his hands dirty and test, observe, practice, and adapt the rules to his own persona.
Examples of popular edges are:
- Trading in line with a clear trend
- Fading the extremes of clear ranges
- Not having to trade every day
- Having a good handle on market Sentiment
- Trading the reaction from evident order imbalance areas
How to Obtain an Edge
The popular belief about edges is that they must be complex, or that they derive from some kind of inside information. Some retail traders believe that using a particular indicator (for example The RSI) in a specific manner (for example shorting when the RSI is above 80) is “the way to create an edge” because it gives them an advantage over those who are not trading that way. Others believe that by manipulating market data (applying physics or some kind of defferential equation to the open/high/low/close) will give them an edge over less quantitatively oriented traders.
Nothing could be further from the truth. Most stable and sustainable edges are quite simple in nature – like the ones illustrated above. Here’s the process that worked for me personally:
- expose yourself, in a non-judgemental way to a wide variety of trading styles (because each trading style is based on a certain edge)
- do some soul-searching, and find out what “beliefs” of those traders resonate most with you. Since each trading style, and therefore each edge is personal, you must agree on a deep level with the principles behind it.
- Specialize. Work the market from that angle time & time again, gradually tuning your “gut” to recognize the conditions that generate the edge you seek.
People waste too much time (years in some cases) optimizing indicator values or candle patterns or time frames, thinking it will give them some lasting edge and correct the instances where the market proved them wrong in the past. The fact is that they never really build an edge for themselves because:
- on one hand, they accumulate experience working the market from a certain angle (specializing)
- but on the other hand, they have the wrong mindset and expectations (attempting to avoid losses, and attempting to optimize).
So, most people completely miss out on the fact that they are in fact building their own personal edge, just that it’s not where they’re expecting it to be, so they just fail to see it.
Where Edges Lie
There is nothing magical at work in the market: the markets move based on buying and selling pressure – nothing more. What is behind that buying and selling pressure? Innumerable traders, corporations, banks, hedge funds that all have different agendas.
It follows that any edge you seek to uncover, or any principle or belief that you wish to apply in the markets, must be a repetitive behaviour that appears regularly in the markets. That is the ultimate test that proves your edge does in fact exist. And as you test your edge in the markets and record your results, your expectancy will reveal whether your edge really does exist in some form or not.
About the Author
Justin Paolini is a Forex trader and member of the team at www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.