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I’m sure you’ve heard of having an edge in the market countless times.
But what does having an edge actually mean?
How do you know if you have an edge, or not?
Is it possible to find an edge in the market without any programming knowledge?
Fret not, my friend.
Because in today’s episode, you’ll discover how to find an edge in the markets and become a consistently profitable trader (even if you have been losing for years).
So listen to it right away…
Hey, hey, what’s up my friend?
In today’s episode, I’ll talk about how to find an edge in the markets.
An edge is something that you do repeatedly that yields a positive outcome or positive expectancy.
One of the biggest issues that traders face is they’re trading without an edge.
It’s not easy to find an edge in the markets, I’ll be honest. Because the markets are close to being efficient.
But if you work at it and put in the effort, you can find an edge in the market.
So I’m going to share 2 techniques that you can use today to find your edge…
Technique # 1 – for discretionary traders
So the first technique is for discretionary traders who trade using support resistance, candlestick patterns, trend lines, etc. It has an element of subjectivity.
As a discretionary trader, you need to have some experience in the markets.
You have to identify certain patterns in the market to realize that whenever this pattern occurs, there’s a higher probability of something else happening.
1. Develop your trading plan
So you need to identify certain patterns in the market and then you need to quantify those patterns and find out whether it actually works or not.
When you identify a certain pattern or behaviour in the market, you want to develop a trading plan around that pattern.
You have to quantify the pattern and under what market conditions would you trade that pattern.
- What are the exact entry criteria when trading that pattern?
- Where do you set your stop loss?
- Which markets do you trade?
- How will you manage your trade if it moves in your favour using a fixed target profit or using a trailing stop loss?
These questions will go into your trading plan to ‘exploit’ the pattern that you’ve potentially found to see if it works or not.
So that’s the first thing – to develop a trading plan around the pattern that you’ve identified.
2. Execute your trades according to your trading plan
Once you’ve quantified the pattern, you have to execute your trades in the market consistently according to the rules that you’ve set for yourself.
And this means that you can’t deviate.
If you’re trading the breakout of 50-day high…
The first 5 trades you trade the breakout of 50-day high, the next few trades you trade the breakout of 250-day high.
You can’t do that. You’ve to stick to the rules that you’ve given yourself. If not, you’ll just be fooled by the law of large numbers.
So stick to your trading plan and execute it consistently. And execute a minimum of 100 trades to get a decent sample size.
The next thing you want to do is…
3. Record your trades
Journal your trades down, including your entries and exits, how much profit you make, what’s your risk-reward ratio.
4. Review your trades
Once you have a sample size of a hundred trades you’ll know:
- If this pattern works or not
- The win-rate
- The average risk-reward ratio
- The markets with the most trading opportunities, etc.
It’s only through reviewing your trades, to actually improve on things.
Maybe you’ll find out that this pattern does not even make money at all, then you can move on to something else.
Or maybe you’ll find out, that this pattern actually makes a profit in the long run. But there are times when this pattern does better and times when it doesn’t. Maybe it works best on Wednesday and Thursday but doesn’t work as well on a Monday.
Or maybe you’ll find out that this pattern works best in the gold or oil market, but it doesn’t work well in the stock markets.
So through your trade journaling and review, you can actually improve yourself as a trader and find your edge in the market.
As a discretionary trader, remember this concept I’ve just shared with you – the D.E.R.R. method:
D – Develop your trading plan around the pattern that you’ve identified.
E – Execute your trades consistently, with a minimum of 100 trades.
R – Record your trades.
R – Review your trades to find your edge.
Technique # 2 – for systematic traders
What about the systematic traders who trade with fixed, rigid rules?
How do you find an edge in the markets?
I adopt both techniques #1 and #2. But I adopted technique #2 in the later part of my trading career where I moved more into systematic trading.
For technique #2, what I did was that I studied traders who had found success before me. Systematic traders who were willing to share their rules and systems.
1. Understand the trading systems
So the best way to go about it is to read books and study academic research papers.
Just to give you a few books that I’ve read that helped me:
- Following The Trend by Andreas Clenow (he also wrote a book on a Trading Evolved)
- Unholy Grails by Nick Radge
- Short-term Trading Strategies That Work by Larry and Caesar Alvarez
Those are some of the books I’ve read that shared the systems and the results with it.
But does it mean that those systems are guaranteed to work if you just trade them?
No, of course not. You should take those systems and then ask yourself, why do these systems work?
You need to ask yourself, what is the why behind the systems.
For example, why does trend-following work? What’s the logic behind it? If I can’t come up with the logic or there’s no reason that to think it should work, I will not even touch the system at all.
For trend-following, the market trends because of the fear and greed of humans in the markets.
When there’s greed in the markets, it’s going to be an uptrend and trend-followers can capture part of the uptrend. And when there’s fear in the markets, trend-followers can go short and capture the meat of the downtrend.
That’s why trend-following works because there are fear and greed in the markets.
And once you identify why a trading strategy or system should work, the next thing you want to do is to validate it.
2. Validate the trading systems
I never trust stuff that I come across even though there are backtested results. I never trust those results. I always want to do my own backtest and validate whether the trading system works or not.
So this is where you do your own backtesting. If you have programming knowledge, then test the system.
If you don’t have programming knowledge, then find someone who can do it and maybe give them the rules that you get from the books and ask them for the results of the systems.
It may not be 100% correct, but anywhere between 80% and 90% similarity, is pretty much okay. Things are aligned with my expectations.
3. Tweak the system to your preference
Lastly, I want to tweak the system to my own preference.
I don’t want to just trade that system blindly, right? I have certain needs and preferences.
For trend-following, Andres Clenow talks about the medium-term trend following in his book, Following The Trend – the highest close over the last 50 days and a 3 ATR trailing stop loss.
For me, I don’t want to trade such medium-term trend-following.
I longer-term trend following. So I traded the breakout of the 200-day, the highest close over the last 200 days. And I adopted a longer-term trailing stop loss to ride along with the trend.
This is how I make tweaks to my own systematic trading systems. I first started by learning from other traders who have come before me, finding a logic to the system, validating it, tweaking it, and then finally trading it with my own live money.
And this is how I find my own edge in the markets, both as a discretionary trader and a systematic trader.
Well, you may not want to go with both approaches. Go with the one that suits you.
But I hope this gives you a good idea on how you can find your own edge in the markets.
With that said, I’ve come towards the end of today’s episode and I’ll talk to you soon.