This "edge" stuff

Discussion in 'Strategy Development' started by BertH, May 16, 2006.

  1. BertH


    I participated in a thread that acrary appeared on, and he gave what I saw as a very good example of what he means by "edge." [related to inflow of funds to mutual funds]
    With that thread being specifically about automated systems (and not edges per se), things moved on.
    Here, I'll ask and hope to get some more replies.

    Can an edge, for instance, be as simple as trading off of a chart pattern like seeing a rising stock hesitate and come back to the 10dma line on shrinking volume followed by a resumption upward? [that's a simplistic way of stating it, since likely other "rules" may need to be implemented to aid profits]

    I don't know if one can classify what he's merely seeing on a chart display as an "edge."

    Thanks for any help.
  2. opm8


    In a word, no, that is not an edge. No technical analysis is. That is not to say that TA is useless, far from it. Just that an edge lies elsewhere.

    Edge comes from risk control and trade management. You need to make sure that your trading system/methodology is up to snuff by the following measures: your losing trades never amount to more than X points per trade (using a futures contract as an example), and your winning trades return more points on balance than your losing ones, when taken as a whole over a large sample.

    For example, (and I know this is towards systems trading, but the meaning is the same) suppose your backtested results or large sample group of actual trades shows 30% winners, 30% losers, and 40% breakeven. Let's assume your losers are always a fixed amount, like 3 points. And that your other trades either return 10 pts or zero points (you don't exit the trade unless you have >= 10 pts).

    Using a 100 trade sample group for the sake of example:

    30 losing trades x 3 pts = -90 pts
    30 winning trades x 10 pts = 300 pts
    40 b/e trades = 0 pts.

    Total: 210 pts.

    Your edge lies in allowing the probabilities to take care of themselves. This requires trading with a very strong control over your emotions, which is why most people are unable to wield this ultra simple edge.

  3. BertH


    Thanks for your help. You said something interesting regarding no TA being an edge in itself. That may well be the case, but my reading of acrary in another thread relayed to a specific example of gaining an advantage on a particular trade. [he wasn't endorsing TA in that example, but was citing a specific criteria for making a trade]
    I agree though that if you have a system of some kind that provides you with that per-trade advantage, you should come out well ahead over time too.
  4. NTB


    An "edge" is synonymous with the word "advantage". As in an advantage over other participants. To be effective, the 'edge' should be substantial enough and robust enough to provide you with a positive expectancy in your performance outcome. In other words, it should allow you to win over time (after expenses, fees, commissions, etc.). Technical analysis is not an edge because so many people are aware of it and it has no proven capability to provide a mathematically positive expectancy of performance over time. In fact, it's value as a tool is debatable. In short, it provides you no advantage over the masses that allow for a mathematically positive expected outcome.
  5. Buy1Sell2


    The only true edge is capital and the management thereof--period.
  6. Buy1Sell2


  7. I would have thought that the ability to follow and execute ones trading plan consistently, would be ones primary edge, since most simply cannot .
    Whether one trades fundamentals or technicals is a matter of personal preference.
  8. An edge is exactly that, an advantage. How you employ your resources and exploit that edge is the other half of the game.

    Success is impossible without one or the other.
  9. Its amazing how many have no idea what an edge is. Semantics issue I guess. If you cant mathematically prove your trades have a statistical edge over random, across a large period of time with a statistically valid sample set, sample size, and confidence interval, then you have no idea if you really have an edge or not.
  10. tireg


    Thanks to all who have posted. This thread caught my eye because I was in an interview today with an investment firm (private wealth management/HNW managing type) and in the process of demonstrating what I've been working on lately I got asked by a manager what my 'edge' was. I replied pretty much the what you guys have said... being fully aware of risk and exposure relative to expected gains, knowing I have a positive expectancy due to backtesting over several markets and timeframes, being willing to adopt the system etc... but for some reason that didn't satisfy him so he kind of brushed me off in that aspect.

    Anyway, I sent him an email earlier today to clarify.. here's a copy paste:

    "What gives me my 'edge' / how I know my trading methodology will work in the long-run:
    My methodology, systems, and theories are based from my own observations of patterns and indicators, be they technical or fundamental, that preceeded price movement. While I put more weight into technical analysis, I look at how indicators interact with chart patterns on multiple time frames. For me, this has proven effective. In addition, I keep my overall concept simple. It is not overladen with backtest-optimized quantitative formulas nor is it a black box system. The idea is to make money by catching a transition period and riding the preceeding trend to follow, be it up, down, or sideways. I also take responsibility for the results. I don't blame outside influences or the market, since the market does not care that I own the stock. This ties into discipline. While my strategies currently are discretionary, and thus prone to pschological factors, I manage my risk and positions tightly. I am aware of how much exposure and risk I have to the market at all times and the reward I expect relative to that risk. This is what I mean when I talked about finding the efficient frontier of risk and reward. Tying in to this, is positive expectancy. All of these factors relate to the bottom line: profit and loss. As long as my system has positive expectancy, meaning my average loss size * percent losses are smaller than my average win size * percent winners, then over time I will make money. I know my methods and strategies will work in the long run because I backtest them unoptimized over various markets and various timeframes. The results allow for me to analyze what the typical drawdown rates are and see if the gains justify the risk. I also am prepared to and do modify my methods as market conditions change. As you know, no system will work 100% of the time. Finally, I am constantly watching the markets and my positions, as well as looking for new opportunities. In this aspect I am an aggressive manager.

    If this doesn't answer [name removed]'s question, then we must not be speaking about the same thing. If you look at it, we are all doing the same thing; finding stocks we think will move up or down or not change and taking advantage of the price difference between our projection and the entry price. Some people use fundamental analysis to do this, others use technical, and some use astrology or throw darts at a wall. In a conceptual manner, it doesn't matter, as one inevitably comes to the concluding three factors: target entry price, target exit price, and stop price (to exit if the position goes against you). That is what I was trying to get at by demonstrating my excel sheets.

    Interestingly enough, a fundamental-based edge can be more difficult to find as it is qualitative analysis, and thus hard if not impossible to backtest or forward-test. If one relies solely on fundamentals, market timing is an issue not addressed, and one competes with the "efficient-market theory" in which all information made available to the market, including analyst reports, company reports, and press releases, all of which a fundamental analyst would look at, has already been factored into the price. Merits of that theory aside, the markets, however, are becoming more efficient and will continue to do so as the spread of information and analytical tools and computer processing valuations become more widespread and automated."
    #10     May 17, 2006