Edge?
- Thread starter bmwhendrix
- Start date
"Trading with an edge is what separates th professionals from the amateurs. Ignore this and you will be eaten by those who don't" .
An edge in trading is an exploitable statistical advantage based on market behavior that is likely to recur in the future.
To find an edge, you need to locate entry points where there is a greater than normal probability that the market will move in a particular direction within your desired time frame. You then pair those entries with an exit strategy designed to profit from the type of moves for which the entry is designed. Simply put, to maximize your edge, entry strategies should be paired with exit strategies.
...WAY OF THE TURTLE...page 63
An edge in trading is an exploitable statistical advantage based on market behavior that is likely to recur in the future.
To find an edge, you need to locate entry points where there is a greater than normal probability that the market will move in a particular direction within your desired time frame. You then pair those entries with an exit strategy designed to profit from the type of moves for which the entry is designed. Simply put, to maximize your edge, entry strategies should be paired with exit strategies.
...WAY OF THE TURTLE...page 63
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Through my experiences, my understanding of an 'edge' has been refined.
In terms of hedge funds, or businesses, an edge is one fund's competitive advantage over its peers. This can manifest itself through experience, analytical capability, execution capability, technology platform, connections, and access to information. Holding all other variables constant, an increase of each of these will mean a manager has an edge over another. These manager/fund-specific qualitative factors are one of the primary reasons why hedge fund replication strategies do not work. Simply replicating exposures of a 'typical' hedge fund misses this point.
In terms of a trading system, an edge is the system's ability to locate and generate trading signals based on nonrandom price behavior over market conditions. It is important to distinguish a system's behavior over market conditions (re: proper backtesting) and randomness because a random 'buying' strategy will appear to have an edge when the mean of the returns over the period is positive (bull market).
In this context, 'money management and position sizing', 'positive expectancy' and 'discipline' are NOT sufficient to be an edge, though they may be assumed necessary. One of my biggest pet peeves is when people confuse these terms with what is necessary or sufficient to an edge.
The reason that positive expectancy is not sufficient to be an edge is that again, in a bull market, a random buying strategy will tend to exhibit positive expectancy, as will a trading system with an 'edge'. At the same time, in choppy markets, a trend-following system with an edge may exhibit flat to negative expectancy. However, having positive expectancy over the aggregate market conditions is necessary.
Discipline is not an edge in any form. If you don't have discipline you should not be putting money at risk; you are no better than a lazy gambler. It's as ridiculous as saying having an account at a broker is an edge for trading. Most retail traders struggle with this; this is why they are the amateurs at the bottom of the totem pole - risk, and quite often losses - gets transferred to these market participants.
Money management/position sizing is necessary to maximize an edge, however it is not required as one form of backtesting involves trading 1-lots. In addition, normalized-risk trading systems incorporate position sizing/money management into their trading rule, so this could be thought of as a piece of the system itself. Therefore, position sizing is neither necessary nor sufficient for an edge.
Through my experiences, my understanding of an 'edge' has been refined.
In terms of hedge funds, or businesses, an edge is one fund's competitive advantage over its peers. This can manifest itself through experience, analytical capability, execution capability, technology platform, connections, and access to information. Holding all other variables constant, an increase of each of these will mean a manager has an edge over another. These manager/fund-specific qualitative factors are one of the primary reasons why hedge fund replication strategies do not work. Simply replicating exposures of a 'typical' hedge fund misses this point.
In terms of a trading system, an edge is the system's ability to locate and generate trading signals based on nonrandom price behavior over market conditions. It is important to distinguish a system's behavior over market conditions (re: proper backtesting) and randomness because a random 'buying' strategy will appear to have an edge when the mean of the returns over the period is positive (bull market).
In this context, 'money management and position sizing', 'positive expectancy' and 'discipline' are NOT sufficient to be an edge, though they may be assumed necessary. One of my biggest pet peeves is when people confuse these terms with what is necessary or sufficient to an edge.
The reason that positive expectancy is not sufficient to be an edge is that again, in a bull market, a random buying strategy will tend to exhibit positive expectancy, as will a trading system with an 'edge'. At the same time, in choppy markets, a trend-following system with an edge may exhibit flat to negative expectancy. However, having positive expectancy over the aggregate market conditions is necessary.
Discipline is not an edge in any form. If you don't have discipline you should not be putting money at risk; you are no better than a lazy gambler. It's as ridiculous as saying having an account at a broker is an edge for trading. Most retail traders struggle with this; this is why they are the amateurs at the bottom of the totem pole - risk, and quite often losses - gets transferred to these market participants.
Money management/position sizing is necessary to maximize an edge, however it is not required as one form of backtesting involves trading 1-lots. In addition, normalized-risk trading systems incorporate position sizing/money management into their trading rule, so this could be thought of as a piece of the system itself. Therefore, position sizing is neither necessary nor sufficient for an edge.
Interesting Thread...
An Edge is Quantifiable through testing... Yes... and 'persistent through time' would also be true as a quality of an edge...
BUT i think it would be important to try to decipher how potent that edge is now versus its use in the past... so
Is the Edge fading / failing like many edges do (when others discover it and exploit it) - is the edge increasing or staying constant...
<blockquote><b>
If the Edge is 'new' in time and you can also discern a slight increase in its effectiveness then your position sizing could also be increased (rationally) along with it...
If the Edge is 'mature' in time then your use of it and your position sizing could be deployed consistently with extra care taken to watch for outlier / exception events...
If the Edge is 'old' in time (others have discovered it - market rules are dimming its effectiveness) then reducing onces position size could be an important consideration...
If the Edge is 'fading / failing' then no position size may be best and monitoring from paper only may be prudent until it can be quantified that the edge has returned...
</blockquote></b>
As well as considering the idea of FADING the old edge as a new edge although that would need to be tested... too...
Everything has a life cycle... especially in the markets where lifecycle's seem to peak faster than in other arenas...
So where in the life cycle an edge is could be important to your long term P/L...
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Possibly to help source out an edge using a different model than existing financial models... consider the book by Benoit Mandelbrot (fractal geometry fellow) ...
The Misbehavior of Markets...
http://www.amazon.com/Misbehavior-Markets-Benoit-Mandelbrot/dp/0465043550
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The Misbehavior of Markets...
http://www.amazon.com/Misbehavior-Markets-Benoit-Mandelbrot/dp/0465043550
<img src="http://www.enflow.com/p.gif">
Tireg really nailed the salient facts regarding what constitutes an edge. It really surprises me to see how many traders and coaches/gurus don't even understand what an edge really is.... But that would explain the high rates of attrition in the industry... I would emphasize Tireg's comments that positive expectancy does NOT automatically mean that you have an edge.... there's a LOT more that goes into that determination.
Fwiw, I would add that finding a true edge is difficult enough and exploiting it is perhaps as hard since it requires the rewiring of your brain's neural paths and an overhaul of your natural propensity for certainty and the sure thing bet.
I have thought the exact same thing too...
That, possibly, the need for certainty and 'the sure thing bet' is tied in with the dinosaur parts of our brain/mind that equate to direct survival...
as in 'I Need To Know For Certain' that I will survive today... etc..
So maybe the long learning curve almost all traders have is the 'actual' rewiring - re routing - rebuilding of new neural (new neurons) path ways to a higher or different area of the brain that allows successful traders to bypass the dino area that only responds with a flight or fight reaction... and instead pings an area of the mind that responds with a calm acceptance of a probability outcome... I may win... I may not... and that is ok... that is fine... in some this takes longer to build this path than in others... and to some it may be more painful to build than in others...
all of this would be similar to the neural rewiring one has to go through after a stroke or a head injury... to build new neural paths... and the longer you trade the markets the more you will feel that you have had a few head injuries...
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