The Edge defined

Discussion in 'Strategy Building' started by tireg, Aug 3, 2006.

  1. tireg


    A few months ago, I wrote about my thoughts on the Edge. Ever since that question was posed to me, I have been seeking what defines an edge. Before, in my naivete I thought an edge was positive expectancy, or discipline, or money management. Those who were in the know scoffed at the idea and stated that these are things that are part of a successful system, but do not constitute a 'real edge'. For the last few months, the concept of an edge was bugging me. It seemed everyone was talking about pressing the edge and edge this and edge that, as if it were the most obvious thing in the world. It seemed everyone knew what an edge was. Yet I didn't. I mean, I had a general idea of what the results of a profitable system were, and looking back at my own strategies I could see what worked, and what didn't, but I could not for the life of me pinpoint the exact edge, and why the systems were profitable.

    I've finally come to a definition of 'Edge' that I am comfortable with, and clarified how it relates to expectancy.

    THE EDGE defines edge as it applies as:
    "A margin of superiority; an advantage: a slight edge over the opposition."

    Many things can be edges; the most prevalent image I had in my mind was that of a casino, in which the house has a built in 'edge' - due to the probabilities of the casino games being in slight favor of the casino, over time they are profitable. This is a statistical edge. An example of a statistical edge for trading was demonstrated in Schwager's interview with Gil Blake. Blake recognized that the markets were not completely random - there exists pockets of nonrandom price behavior which can be taken advantage of; in his case, more than 70% chance of follow through after x days, allowing him to swap funds. He took this a step further and applied it to many trades throughout the year, applying his edge over many markets.

    Another example is faster execution - someone posted once that if all traders could pick tops and bottoms, those that could do it fastest would make money. This is a competitive advantage; an execution edge.

    Many funds' edge is an analytical one. An analytical edge or informational edge is having analysis that others (re: the market) have not taken into account, thus locating inefficiencies in price.

    The product of the edge, that is, how it manifests itself, is positive expectancy. Positive expectancy is the result; not the edge itself.

    Tying this all together, in a profitable trading system with positive expectancy, the edge is the system's ability to locate and generate trading signals based on nonrandom price behavior, no matter what time frame - seconds, hours, days, weeks, months, years, etc, or style - fundamental, technical, statistical, etc.

    As retired EliteTrader forum poster Acrary has shown, multiple uncorrelated trading systems/strategies come together to smooth out the equity curve and create consistent profitability. Probability also plays a role, as the more vehicles or trades generated, the more the effect of the edge, i.e. expectancy, plays out.
  2. Nice summation.
  3. tireg


    Would also like to add-in this piece by Acrary that illustrates the point even further:

    The edge vs market data

    "Here's a example. Years ago when the Stock Traders Almanac first came out one of the tendencies described was the last two days and first 5 days of the month being market movers. I verified the condition existed and persisted from month to month in the SP futures. I could have stopped there and used a envelope strategy to try to catch any trend starting around the end of a month. This would be how a person with only market data might analyze the market. I went on to try and figure out why the market moved during those days. I knew mutual funds were big and thought maybe it was caused by inflows into the funds. There were and are sources of mutual fund flows available so I got some data and did some tests. I found that fund flows in and out had a lag due to reserves in the funds, but the tendency was for large inflows to be put to work within 5 days after receipt and outflows caused selloffs in the funds around 3 days after the funds were disbursed. I setup the software to do a weekly trade based on buying when inflows were strong and sell when inflows were weak. If the inflows remained on the side I was already in then no new trade was initiated. From 2001 - 2002 there were no losing trades and the average winner was 28k per-contract in the SP. That's a difference between mapping to market data and pulling the profits out of the market based on a edge.
    I went on to build a whole series of models based on this edge things like ... if the market early in the week went against my edge then I'd initiate new positions to take advantage of the opportunity knowing they'd be active within a day or two.
    Anyway, there's a example for you. There's lots of these edges around...just don't expect to find them in the o, h,l, c data."
  4. dan05


    Hi tireg

    Nice thread. I fully agree with you.

    Check this.

    It is a statistical significance analysis of the edge of a system
    I"ve been testing for some months.They define their edge as the ability of the system to predict the path of the market.

    As is stated in their conclusions.

    "We_can_conclude_that_on_average_considering_Test_1_we_get_an_edge_of_21.20%_above_the_50%_chance.__Considering_Test_2,_the_edge_is_13.72%_above_the_chance.__We can also conclude that the longer the prediction within the day, the better the odds for the predictor."

    Their system is capable of finding non-random moments in the market, or pockets of predictability and make money from them.
    Thats their edge.
  5. My edge is simple. No thinking! Either a trade lines up fitting my parameters, or it doesn't. Enter the trade with a defined stop and profit point, and a time line for it to happen. Winners are bigger than losers and the winning % is enough to be profitable.
    When I have the discipline to follow that simple method I make money. When I don't....well, we all know what happens.
    Moral of the story....the edge is discipline, period!
  6. Are you saying "Edge is 'Buy Low and Sell High' " in a different way? :)
  7. romik


    an edge in business is the ability to make more than lose, did i miss something?
  8. Anyone saved a deleted thread named
    >>What exactly is an "edge"? >>
    appeared here on ET last March?...

    Please PM privately. Thanks,
  9. Play it again, Sam!
  10. Great contribution... :eek:
    #10     Aug 6, 2006