In trading an “edge” is a mathematical advantage. It basically means that if a trader takes enough trades of a certain type that he will, over a period of time, he will be profitable. Traders have to learn to structure their trades in ways that give them an edge; a mathematical advantage, if they want to be consistently profitable over time. The problem is edges can fleeting and are small. And edges need to be based on math which some call an “exact science”. Others say it is not an exact science. Nevertheless, at the bare minimum math seeks to use logic to understand and prove logic between quantities and objects. The problem in applying math to the market is that the market is not exact and it is full of uncertainty. Hence, a mathematical advantage is always going to be small. And it can be fleeting. That is, it happens quickly and can disappear quickly. But the good news is that is all that is needed to be profitable.
So traders have to structure their trades with scenarios or setups that involve entries, initial SL’s, initial PT’s based upon an edge they have found or discovered and employ. But that is not the end of the story. They now have “manage” the trade for a mathematical advantage which involves execution, on the fly adjustments of SL’s and PT’s within the dynamics of the trade as it unfolds. Since the market is filled with uncertainty no SL’s or PT should be set in stone. They all need to be adjustable but also have a mathematical logic, behind the initial setting of SL’s and PT’s, and any subsequent adjustment that is based upon “how” (i.e. the dynamics) the market is unfolding, in respect to the trade taken.
If you follow my journal I structure averaging down to give me a mathematical advantage. An edge. Even though the gurus “choke on their spittle” over the concept. I also take what I call straight scalps, long or short, with no averaging down.
When in this “structuring moment” of the trade it is only the INITIAL structure, based upon a mathematical logic. And is for SETTING the entry, initial SL’s, and initial PT. All those things are subject to adjustment as the trade unfolds (i.e. the dynamics or the “how” price is being made) EXCEPT my entry. You have doubtless heard (from the guru’s lol) that the only thing you can control is your SL and some might say your profit target, or PT for abrev. I would beg to differ. The only thing you can control is your entry! The market controls all else. It determines, by it’s dynamics, if your SL and or PT was or is appropriate. Therefore, I will adjust my SL and or PT based upon the dynamics as the trade unfolds. I CANNOT adjust my entry as it is already made and has become a reality in my original structure once I take it. I am “in” the market so to speak. That fact, I cannot change. It has happened. I can only do two things as concerns that fact. Exit or add to it. If I do the latter it needs to have a mathematical basis within the immediate and larger context AND within the present dynamics taking place. However, in the example below I discuss straight short and long scalps with no averaging down or scaling in as some prefer to call it LOL.
Allow me to give an example:
Price is in a range (defined as 20 or more bars of sideways PA). The larger Context is a gap down open from a previous bear channel. In other words, weakness is in the distant past (from a 5 min ...15..min perspective). The fact that we are now in a sideways range indicates the bulls are trying to reverse that weakness and they want a reversal up. But the fact we are staying in the range indicates the bears want the range to just become a bear flag. The bears want a downside BO. Remember, in a larger context a bear channel i.e. a downtrend, a 20 bar TR on a 5 min chart is like a 7 bar bear flag on a 15 min chart and a 3 bar bear flag on a 30 min chart. So, the tug of war between the bulls and bears continue until we get a successful (read my journal for def of a successful BO) and one side wins (for a while). Now, in that struggle the TR by it’s nature reveals that both are about even (thus creating the range or there would be no range created...let than one sink in as it applies to ALL price patterns even though some would say price patterns are hogwash LOL). One tactic or technique I use in such an environment is fading the outer limits of the range (both bottom and top). There is a 70% to 80% chance any BO attempt, bottom or top, will fail within 5 bars and price will trade back into the channel or further down or up into it, even if it never actually broke the upper or lower limits on the attempt. In the larger context those odds favor fading the BO attempt out of the top. Why? Previous weakness to the left before the range began. So 80% from top maybe 70% from bottom.
Ok, so BO attempts and their failure or success are now based upon mathematical logic. Now what about the entry..SL..PT in the initial structure of the trade. I got the math on my side in BO attempt failures. But where does a mathematical basis come into play in my initial trade structure?
Ok, my initial entry, if I am conservative, will be to short when price is in the top 1/4 of the range. If not so conservative, I may start shorting in the top 1/3 of the TR. Initial SL will be say 2 to 4 points above the top of the range or above my entry if using a set SL (maybe a little more in volatile market conditions) OR an alternative initial SL looking to the left and finding the closest or lowest (in terms of SL distance) swing high before the range began and placing the initial SL just above that swing high thus using an initial PA SL, as opposed to a dollar or set point SL. For the initial PT I use the traders equation that brooks teaches:
The probability of success X the initial reward needs to be greater than the probability of failure X the initial risk.
To come to the probability part of the equation I have to make a judgement call. To help me make that I ask: What just happened in price action? What are the chances of price hitting X target BEFORE it will hit X SL? Then I mentally adjust the target to give me a higher probability of success. If the probability of success is high say 60% to 75% then the left over percentage becomes the probability of failure figure. Once I assign the probability number I can plug in the numbers into the equation and structure my SL and PT to give me a positive traders equation. Mind you I don’t do this manually so much as mentally. Then I place my trade.
So, now that I am in the trade I have to manage the trade according to the unfolding dynamics of PA AFTER my entry. I have to monitor actual risk and actual PT. I want at least a 1 point scalp and prefer 2:1 reward to risk but will sometimes settle for 1:1. Often, when price moves immediately in my favor after my entry I can get a 3:1 or 6:1 reward to risk based upon my actual risk I suffered after my entry. If I can get that kind of reward I will grab it quickly even BEFORE my initial PT is reached because depending on the type of setup I entered on, I know that paper profit can disappear quickly. That is why traders get whipsawed. Price moves immediately in their favor..they get greedy thinking more is coming they will hold and bam suddenly price reverses and as quick as they saw a gain, they now see a good paper profit with a GOOD R:R, evaporate and they are now in a losing trade. See, they had a mathematical advantage but they did not take advantage of it in the dynamics of the unfolding trades. On most setups (there are some exceptions like in strong BO’s) if the market gives me a 3:1, 6:1, 8:1 ..etc reward to actual risk I would mathematically be foolish to not take it. I CANNOT go wrong taking it as that is an edge i.e. a mathematical advantage and math is relentless. Greed as well as fear can obliterate our “edge” as price dynamically unfolds. That is why, if you have looked at my chart in my journal you see me jumping in and out. The dynamics of the trade just gave ME a dynamic edge and I am taking it! It ain’t magic as ON aka Fedex likes to announce LOL.
Things are a bit different when averaging down although much of the process is very similar.
I will, perhaps at a later date post more on structuring a trade when utilizing averaging down.
I am posting this writeup I wrote in this thread because it is a thread about educators that tend to only discuss entries and rarely discuss managing a trade. I will also post it in my journal.
Happy trading
Volpri
