💡 Trading Edge
You always hear traders talk about Edge and Strategy, but what really is it? What do they mean? How can it benefit you as a day-trader?
🎯 What is a Trading Edge?
A trading edge is the reason you should be in a particular trade. An edge means you have an advantage over other market participants. Maybe the market is not efficient, maybe the market is not pricing it, maybe there is an imbalance, liquidity issues, the reasons go on and on.
A true edge should make you profit over time. It should be better than a coin flip, otherwise, it is a simple 50/50.
🌟 Confluences: Combining Multiple Edges
The more components that make an edge, the higher probability a trade can workout in your favor. Those are called Confluences. When multiple things align, it can create the golden opportunity for an entry, which should not happen frequently throughout the day, should happen only a few times, if even. This is because your entry is in an advantageous position compared to other market participants, thus gaining an edge.
📈 Market Conditions and Edge
You want the direction of the instrument you are trading to be smooth, and not choppy. You need to make sure your edge is scalable, so as you progress as a trader, you don't go searching for another edge because yours doesn't work anymore, or gives no advantage. Edge deteriorates and fade over time as markets become more efficient and 'find' the edge in a way, but that leaves room for other edges to be created.
There are certain edges that will only be available at certain liquidity environments. Some edges can take advantage of wide spreads in an illiquid environment, some can take advantage of tight spreads in a super liquid environments, like the ES futures for example.
🌀 Volatility and Range
Ideally, you are looking for a wide range so that volatility may be present, and for more setups to be in play. Trading in a 3 point range doesn't give as many opportunities as 30! If an instrument is ranging only 3, you'd have to size up, and nail entry, but with 30, you can take less risk.
You are always looking for momentum, as it is the sole reason behind liquidity expansions and a larger range. If an instrument is stuck in a tight range, and chopping, why are you still in it? Liquidity expansions create opportunity. Whether that is a trapped short blowing up to the upside, a blowing up long exploding to the downside, it creates those edges you want to capture. This is where the market can be mis-priced, and where mean-reversion style trades can be implemented for a profit.
❓ Recap: What is Edge?
Let's recap Edge. It is the Reason you are in a trade. If you are getting in a trade, long or short, because you think something will happen based on an opinion, twitter user, news, some headline.. ask yourself, is that a valid reason? When you lose on that trade, who will you blame it on? Yourself or the market?
🤔 Questions to Ask Before Taking a Trade
Once you spot a potential setup that contains your edge, or see it approaching / forming, ask yourself a couple questions:
- 🎲 What is the probability this works in my favor and my edge works?
- 🔮 Do I expect a momentum push the other way?
- 📏 Is there range for today, or are we stuck between two important pivots?
- 💰 Can I get in and out with my size with no problem at a favorable price?
As you see, it's not just a one thing decision. It's multiple things that are decided on the spot, that amount to a trade, whether losing or winning, but a part of your overall trading.
🧘♂️ Trading Mindset
- 👐 You MUST be okay with sitting on hands doing nothing.
- 🙅♂️ You MUST be okay with missing out.
- 😌 You MUST be able to control "FOMO" and not act on it.
- ✅ Just because you take a winning trade, doesn't mean it's a good trade.
- ❌ Just because you take a losing trade, doesn't mean it's a bad trade.
📊 Probability and Win Rate
At any point in the market, there is a fifty percent chance you make or lose money, if entered blindly. Historically speaking, that is not the case as we can calculate where you entered and the probability of a up/down directional move based on past data, but since there are only two directions, and past does not imply future moves, let's pretend it is a fifty-fifty shot. You do not want to be a fifty-fifty trader! Although there is nothing wrong with having a fifty percent win rate, as long as your average winner is bigger than your average loser, going in blind is a recipe for disaster and can have a spiraling effect on your mental edge and trading psychology.
📜 Trading Rules and Analysis
You need to create a set of rules for yourself. Multiple criteria need to be met before entering a trade, and exiting. Otherwise, your trading data is essentially random and a bunch of noise. How do you analyze noise? How do you improve if your data is random!
💪 Understanding Yourself as a Trader
You need to understand yourself, when to sit out, when to get in a trade, when to size up, and when to size down. That alone is an edge to yourself.
Your job is to make money, not to place trades. No one would rather stay an extra four hours at work for the chance to either double their paycheck, or give last week's paycheck up. When you see your paycheck, you go and cash it in. Compounding is the real benefit, the market won't go anywhere. It will be here tomorrow, next week, and next month. You need to make sure that next week, next month, next decade, you will still be here for it and still have money to bet. Protect your profits, nothing is easy to gain, but easy to lose - takes five to make five, and one to lose ten.