What defines an "Edge".

Discussion in 'Trading' started by redbaron1981, Mar 29, 2015.

  1. First of all I am really looking for responses from the following ET members listed below. My reasons for selecting like this is after reading many of the posts generated by these posters my perceptions are that these traders are successful on a day trading timeframe. Should you consider to be at these posters levels then feel free to contribute. What I am looking for assistance with is what exactly defines an edge and moreover a discretionary edge or if there is even such a thing. The list is as follows and not in rank order:





    Rearden Metal


    Acrary - However Acrary's edges seem to be more of a quant style derived from the use of software, however please feel to contribute of relevant.

    It seems that trading forums become so diluted with the gibberish that gets construed as gospel by "non traders". We see literally hundreds upon thousands of systems that are created around things that I consider to be not even market related. Unfortunately certain types of TA fall into this category which will probably annoy a lot of people by me saying so.

    For me an edge is something that has to be constructed around exploitation of the sometimes repeatable patterns of traders and unfortunately most TA techniques fall into this category.
  2. Here follows is a few quotes that I found to be relevant to the discussion over on forexfactory;


    I do want to make it clear, though, that my only input is price. I don't use volume or any sort of fundamental analysis. I don't want to give you the idea that my screen is cluttered with a million lines and indicators; at the same time, I follow carefully constructed rules that cover every potential occurrence. I never even contemplate whether or not to enter a position: it is a given based on my rules, as is every single action that I could possibly take with that position as a reaction to the market.

    To put it simply, there is no thinking involved in any of my trading decisions; in fact, I wouldn't even really call them decisions, since they were decided along time ago. Now they are simply givens. All of the thinking (discretion) went into creating the strategy, following it is simply about discipline. Discipline only ever wavers during drawdowns, and even then it is kept in check by more rules. Rules, rules, rules - they are what keep me confident enough to follow a strategy consistently; sane enough to live everyday without a frenetic fixation on the market; and humble enough to know that the outcome of any single trade - or series of trades - is completely out of my control. After all, I'm just following orders. Just make sure that those orders are grounded on a tenable foundation - that you actually have a solid edge at the core of the entire process.

    I would say that conceptually most successful trading systems capitalize on capturing herd behavior; the edge is simply derived from quantifying and mechanizing this behavior. If the herd change how they collectively react to these various factors, then there goes your edge. The bet - or, I suppose, the lucky or uncertain element - is the belief that aspects of human nature dictate that the crowd will always react in this way (obviously given a sufficient sample size, etc). It is merely a belief and that is all it can ever be.

    Anyway, you can't even begin to do any of that until you have a strong foundation - and this is precisely where many get it wrong. They want a mechanized model, so they do a 'backtest' of various rules that they have composed. However, what is the logical basis for those rules, aside from the fact that they appear to historically work? Finding that you make x% over x years based on rules that are not grounded on a specific understanding of market dynamics is likely to be no more than a mere coincidence. To borrow from Taleb's monkey example in 'Fooled by randomness', if you tinker with enough variables you are going to find something that fits. This of course is the process of curve fitting - something that is easy to inadvertently do, mainly because it is so perversely satisfying and so seemingly reasonable.

    The only way to really avoid this is to first truly understand what your chosen inefficiency is before developing a system to exploit it. And I don't mean understanding exactly why x bank placed x order that moved the market x amount on xyz date; rather, the overriding concept that what you're designing will attempt to capture.

    I know this all may seem somewhat esoteric, but figuring out an edge can be somewhat of an esoteric (and exhausting) process. Doing all of what you have done; learning all that you have already learned; falling into all of the traps that you have likely already fallen into, are generally all prerequisites to the process of understanding, in a broad sense, why certain things tend to happen more often than not. It is understanding why, given certain identifiable situations, people 'tend' to act in a particular way with at least enough reliability to exploit."

    The most important thing is to think critically for yourself, and to have a reasonable basis for every trading action that you take. Never fall into the trap of thinking that you possess some prescient instinct for the markets. There are few shortcuts to the process, but if you approach it without preconceptions, unsubstantiated ego, or a get-rich-quick mentality, you will be leagues ahead of many that are in your shoes.


    Consider that almost every new trader believes that success begins and ends on this picture in front of them, then consider that 95% of these people fail. Next, ask yourself why you think studying the same tool which countless others have failed with is the best and most efficient route to success.

    Charts are used by newbies as a sole tool to predict price. Professionals know this, so they use charts to determine what all the newbies are thinking. Therefore, charts often times provide the right amount of information needed to trick a trader into losing his money. Big players need order flow to get into and out of the market. What better way to do it than to buy at a point you know everyone and their dog is going to sell? The market will follow the big money on such a transaction, because all the speculators in the world cannot provide enough buying/selling power to eat up and oppose a bank’s intervention.

    So anyway, my long winded point is to question the importance of charts. Can I profit off a naked one with a buy/sell button only? Probably. Should I devote years of my life studying a TOOL of the market instead of the market itself? Probably not. Again, this is the thought trail I walked down to take me where I am today. Hopefully it benefits you as well.

    I personally exploit market inefficiencies through mispricing and crowd overreaction.
    hirtop likes this.
  3. Merlin

    Its almost impossible for a novice to come up with a good premise because they dont understand whats going on behind those little candles. instead they look at the candle itself, just seeing the surface, and making little patterns in their head or with a computers. but behind the candle is where the magic is, thats where the people are. i call it "thehuman element". the best premises i have ever traded are rooted directly in human nature. humans are predictable to some extent, and herds of humans are even more so. if you can come up with a premise based on human observations (in regard to trading and the markets, not talking vodo crap here), and then the data tells you its legit, chances are you got winner on your hands.

    i usually trade the "human element" of the market (ie reading the order flow and guessing what the major players are thinking/doing). i use the same exact philosophy in the stock market, currencies, oil, bonds, you name it. and it works everywhere, in every timeframe from 5mins to 5years, because the human element remains the same everywhere.

    For a numbers guy you sure have a wide vision to be able to see the "human element"! its so easy to get wrapped up in statistics and forget that the basis of all this chart movement is is people! and people are pretty damn hard to predict, proven by the "long tails" seen in almost every market distribution.

    Ever asked yourself what causes a trend?? behind every chart there are real people making trades, some short term, some long term. for the technical guys that is sometimes hard to accept. they want to think the price is doing this or that because it hit some fib line or is overbought etc. but it really comes down to to the humanside of things. you know that commercial from Dow chemical... "the human element"?

    So what causes a long term up trend? well, long term buyers of course! likewise, shorterm sellers are the cause of a short term down trend. thinking of the market in human terms is a big advantage i believe, it really gets you focused on what is actually moving the market and can help you predict where its going too!

    This is why im such a fan of watching price action during big news reports. you can get some real insight into what everyone is thinking by how they react to the news. for instance, if you are unsure who is buying the market lately, you can somewhat decipher who it is and what their intention is by seeing how they react to positive or negative news. and then during the following week, you can use this information to help you answer questions like "is the buying over with?", because you know who the buyers are!

    To tell you the truth, i have no hard and fast rules when it comes to trading news. i am mostly a quant trader, but for the news i trade on crowd emotion and plain ole market experience.

    What i try to do is focus on the times when human emotion (which is somewhat predictable) is most at work. for instance, there is a lot of emotion and crowdreaction when the NFP report comes out. if you study just NFP report days, then you start to find some interesting things.

    The "subset" of patterns i am looking are patterns caused by events. i find that when a pattern is caused by a event it is rooted in crowd psychology and will persist over time (ie it is predictable).

    Expecting a logical market reaction to news is very naive. just doesnt work like that, never has.

    instead of taking the arbitrary logic in our head and forcing it upon the market, we should be listening to what the market is saying and forcing it upon our trade decisions. if you know how to listen correctly, the market can tell you a lot during news releases.


    So what is a trend exactly? Technically it is any sustained unidirectional price movement. As should be apparent by now, for a trend to develop there needs to be a greater volume of demand to buy (sell) then there is to sell (buy) across multiple price points.

    Trends develop and are sustained for many reasons, but the most relevant for our purposes is the fact that they have a tendency to perpetuate their own continuation. That is, movement in a given direction will generally entice others to initiate orderflow that will help exacerbate the move. This is of course the direct result of the common trader’s propensity to implement trend following systems. You can visit any random trading system thread on ForexFactory to confirm this propensity.

    Operating from the premise that a sustained unidirectional price movement (trend) is the result of significant unidirectional orderflow, and that this unidirectional orderflow has a tendency to increase in volume as more and more trend following traders discover a justification for initiating trades, how is it that trends are ever reversed? If you have been following along, it should be obvious that the only permissible way to halt the advancement would be to offer supply in greater quantity then is being demanded.

    The general premise is that because all participants in the market are human, mistakes are inevitable. It can be something as simple as a temporary mispricing that a trader can arbitrage or as complex as finding intrinsic value to current pricing overshoot opportunities. I personally find myself drawn to this camp as a news trader looking to capitalize on improper expectations.
  4. Some of the above are some the closest discussions around actually finding something that is exploitable but I would love to hear contributions from the posters mentioned earlier.

    I personally have been trying to learn this game for around 6 years and feel that as each year draws to a close that I am one step closer to finding something that is reliably exploitable. Obviously being close and having are two different things. My journey has taken me down many different roads and I am currently on the premise that having a reliable system is about exploiting the herd of the dumb money as rearden metal calls them. So I would like the guys here who have made it to contribute ideas to the discussion. I do have a feeling that this will be a very quiet thread but I guess there is no harm in trying.

    Thanks in advance to anybody who contributes anything precise and on topic.
  5. Buy1Sell2


    The only true edge in trading is capital and the prudent use thereof. This is called trade management and is paramount to successful trading.
  6. I think there are bigger 'edges' than trade management and trading capital. I think they can only be considered an 'edge' at a real push.

    Take someone like sellindevol666 or convex. Or red_ink_inc from the olden days of the pnl thread. Big big bucks everyday with alarming consistency. They clearly had a powerful edge.
    I can't think of any members who post here nowadays who clearly have an edge, but there are a few at trade2win who demonstrate it in real time with amazing realtime calls backed up with statements.

    The fact that they get it 'right' so often, and with clear stops that are usually smaller than their eventual reward suggest that they have something else going for them other than just 'trade management'
  7. Buy1Sell2


    We are in agreement then---what you have defined is prudent trade management/prudent use of capital.
  8. I agree with you brianharvey,

    One only has to look at the following link to see what's capable.


    With regard to stops although I do believe them to be important I far more agree with what Rearden metal says.

    "Here's something that even decade+ veteran traders have trouble understanding:

    The market does not know or care where you got in!

    Flame away, but all the best equities daytraders I know will ALMOST NEVER USE STOPS. 'Being up' or 'being down' on a position shouldn't ever change the way you trade it. The market has no idea where you got in. If you're long and the stock is slowly inching up during a general market selloff- would you cash out just because you're up? That's not a winning way of thinking. If you have a good feel for the market, trade based on what the stock is doing, never based on your entry."

    Also ghost_of_blotto mentions stops in this thread:


    Simply trading with defined risk to reward ratio is not an edge. Imo markets are too dynamic for this unless we are talking quant strats. I.E money management alone does not enable one to succeed.
  9. Buy1Sell2


    No, but the trader does. This is why stops are set outside the noise so they are less likely to be hit. Then position size is adjusted accordingly so the loss will not exceed 2% of TLNW. Then, trailing stops are placed outside the noise to reap the most benefit of the winning trades. This is the very essence of capital and the prudent use thereof, which is the only true edge in trading.
  10. On this basis yes I agree but maybe we have drifted off topic somewhat. Money management alone will not make an unprofitable edge profitable. Maybe I should have been more descriptive but what I am looking for is to define an entry based around an edge or inefficiency as it can also be called.
    #10     Mar 29, 2015