Does Your Trading Strategy Have an Edge ?

By | September 10, 2014

Having a strategy with an edge is often mentioned in trading literature as a prerequisite to success. Despite this fact, I think it’s still a misunderstood concept. Why am I saying this ? Well, ask yourself, or other traders you know, what exactly is your edge in trading ? In other words, what makes you think that over the medium and long-term you’ll end up with more money in your account than you started with ? Common answers to that, apart from a blank stare followed by total silence are: the indicators that I am using, the bar/candlestick patterns on daily charts (because that’s what ‘educators’ recommend :) ) or the discipline of risking ‘only’ 2% of equity on each trade. With this kind of responses, there is no surprise that 90%+ of traders are losers.

The problem lies within the fact that those are merely tools. I’ve never heard or read about a successful trader saying that the key to his long-term success is to enter a long position when RSI is at 20 or a short position when he sees a pin bar on a daily chart. What gives a trader an edge is how he puts together all the elements in a workable and logic strategy. This process will take lots of time and hard work because it’s not easy to find a successful trading approach that is right for you.

My advice to any trader out there considering opening a live trading account or buying trading education is to ask this question: What is your edge ? If you don’t get a logical response to that, you’re not ready to go live or the educator is selling worthless junk. And because I started this, I think it’s only fair that I answer the question as well. My strategy’s edge comes from 2 main directions: Firstly, keeping losses small: I take a maximum of 2 trades a day and my maximum loss targets are 1% of equity per day, 2.5% per week and 10% per month. So in the  absolute worst case scenario, where I would 1. take all trades a month and 2. all of them are losers, my loss would be 10%.

Secondly, maximizing winners: most of the times, there are a few losers, a few winners, with the net result slightly negative or positive. But there are also times when larger moves (the term ‘large’ is relative to the time frame used) allow me to pyramid the small initial position into big profits, with a final risk/reward ratio of more than 1/30.

I hope you found this useful and thought provoking.

PS: If you haven’t figured out why trading ‘educators’ keep touting the superiority of daily setups, shoot me an email. :)

10 thoughts on “Does Your Trading Strategy Have an Edge ?

  1. J W

    I quote: ” But there are also times when larger moves (the term ‘large’ is relative to the time frame used) allow me to pyramid the small initial position into big profits, with a final risk/reward ratio of more than 1/30.” and i would like to find out how your pyramiding in the intraday works. Personally, i pyramid only in the D1 timeframes and trail my stoploss. Prices are usually less volatile there and do not hit the trailing SL randomly. However, i realise that trying to do the same pyramiding in the smaller timeframes almost always ends up with the SL being triggered, incurring a loss instead. Would love to hear your take on this one.

    Reply
    1. JLTrader Post author

      I’ve put a couple examples of pyramiding in the Strategy tab. I used to concentrate more on h4 and daily time frames a few years back but for over a year now I don’t feel that the market moves enough to allow me to trade daily anymore. The thing is that for pyramiding to work, you need a trend…there are more trends on m5, m15 1hour than on daily. Of course there will be a lot of stop losses triggered, but I think that’s the same for higher time frames…you only need more time to realize it. Check out Peter Brandt who uses weekly and monthly charts, he has a success rate of under 40%. I usually find that my stop losses are triggered when the market lacks momentum and it’s still in consolidation/side way movement. That’s true for larger time frames as well.
      One more thing to add…although I open every trade with the hope that if it goes my way I’ll be able to pyramid, that’s not always the case. It depends on price action.
      Hope this helps.

      Reply
  2. George

    @PS – I don’t think I understood why ‘educators’ keep preaching the superiority of daily setups. Could you elaborate on this a bit? Thanks

    Reply
    1. JLTrader Post author

      @George I think that there are 2 main reasons:
      1. Daily charts can be marketed to those who hold 9-5 jobs or just want to do some trading ‘on the side’. It implies that very little work is necessary, just check the charts at the end of the day and that’s it.
      2. Whether they admit it to themselves or not , they know that their methods don’t have a real edge and will end up losing money. Using daily setups will just take a lot longer for those who pay for their services to realize it as well.

      Reply
  3. George

    Thanks for your reply; both points seem valid. But it looks like you address only the case of pundits. There are also another kind of ‘educators’, successful traders, which prefer a daily timeframe (for stocks, at least).

    Another question, related to the strategy article (I post it here, as the comments are disabled in the strategy tab): I don’t think I get the rationale behind the first entry (long entry) in http://i2.wp.com/www.jltrader.com/wp-content/uploads/2014/08/GER30M151.png (“E1: 8992 SL: 8980 -> Risk:12p”). As we talk about a long trade, I would expect an entry as soon as we get an upside breakout from that triangle. That would be around 16 Dec 09:15, 9030. And even then, the moving average on that chart (blue line) is still declining and the price is still below it (which would contradict different definitions of an uptrend), meaning the long trade would be in the opposite direction of the general trend, and as I think I read somewhere in your blog, you prefer to trade with the market, not against it. So, it’s obvious that I am missing something here :)

    Reply
    1. JLTrader Post author

      I believe there are successful traders out there trading all time frames, there’s no problem with the daily frame per se. By ‘educators’ I was mainly referring to those selling ‘price action’ forex courses.
      About that trade example: -the MA is used just as a general visual help to see how far away the price is from its last 200 periods average. I don’t use it in the traditional trend following way, long when it points upwards, the price is above it, and short when it’s the other way around.
      – the rationale for the first entry: 8980 proved to be a good level where the price bounced back on 13th November. As it can be seen in the picture, it gained further significance when the price bounced off it again on 12th December. It all looked like a good candidate for a double bottom, together with the gap down open, which I expected to be filled.
      I do like to trade with the market, and in this case the market (as defined by h4 or daily ) was up. Stanley Kroll mentioned in his book that the best way to trade is with the major trend (up in this case) and against the minor trend (down in this case). Another way of saying, ‘buy the dip’ or ‘sell the rip’

      Reply
      1. George

        I see now, thanks. I guess we kindly disagree on the general/major trend of the GER30 at 16 Dec 07:15 (when, as I understand, you opened that position), but, as the old saying goes, that’s what makes a market. Nice quote from Kroll.

        Reply
  4. Otto

    Great post and great blog!
    As for your edges you mentioned (keeping losses small, maximizing winners), I think they are not edges on themselves, especially the first one. IMO it would not help if you entered randomly because you just could not maximize your winners enough. So your real edge should be in your entry because that is what you choose carefully, and secondly your exit. Do you agree?

    Reply
    1. JLTrader Post author

      I agree, I think it’s just another way of saying the same thing: by carefully choosing your entries and exits you’ll manage to keep losses small and maximize winners.

      Reply

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