The Glory of Edge

What is an Edge? 

I used to believe that it an edge was the advantage you could develop over other traders.  In other words, the edge necessary to be profitable was likely some highly complicated strategies that the hedge funds might use with various correlations.  But if this was the "edge" then the retail investor stands no chance. 

As I progressed in my development, I came to realize that you do not need to have a complicated strategy, an edge can be developed by understudying your trading setups inside and out and applying them consistently.   While this certainly was closer to being correct, it is a methodology and not really an answer. I've since come to the realization that "edge" is the edge your system has over randomness.  

Fooled By Randomness

If markets are random, there is no edge. Nothing will make you money, not psychology, technical analysis, trading systems, discipline, or expert money managment.  Thus, it becomes imperative to ask whether markets are random or are they non-random.  

Humans are trained to see patterns in data that does not exist. We can find "bull flags" "head & Shoulders" patterns in completely random generated data. Consequently, I do not believe that training yourself in these chart patterns is especially helpful in developing an edge.

Certainly, much of the market action appears to be random. But given that every trade likely has a strategy behind it, can it be said that the market is truly random?  I  picture the market as a school of fish, every individual movement does not appear significant, but some times, the entire school turns in one direction. 

If your the system does not provide more edge than over a random market, then your system is the same same thing as trading a random market.  It is impossible to make money. 

In other words, if we do not understand the market action, or if our system does not know how to trade it, then the signal is no better than random.  

To make money in the market:

1. There must be a non-random pattern
2. the pattern must be recognized
3. The strategy must be executed properly

There is however, certain times when non-random signals appear. The objective is to separate random from non-random movements and to create a trading strategy that allows you to capture the signal. The difficulty is that randomness hides non-randomness  (signals).

Thus, the question we should ask ourselves is how do we develop this edge?  How do we avoid just trading the noise and ensure that we are not only trading legit signals but doing so profitably.  Given that  some of the best traders often have win rates in the mid 50s%, it is not easy to do. 

Some of my observations that I've built my trading strategies around  are that

1. Stocks rests in periods of consolidation

2.  Volatility leads to more volatility

3. A stock that trends into consolidation will often continue the trend after a volatility expansion.

4. If a stock makes massive move on high volume and the pull back is shallow, the next higher move can be very explosive. 

I've turned these observations into strategies and defined them in my playbook. 

My continuation anticipation setup buys strong stocks in periods of consolidation.

My momentum burst setup buys stocks that have consolidated and have shown their first range expansion -- (volatility leads to more volatility. )

My Fishhook setup looks to capitalize on big volume movers that pull back and then resume the move. 

Confidence

My playbook only works because I have confidence in those setups, Ive detailed.  If someone were to show me a set up, it would do me no good until I have researched it and believe in the setups take advantage of a non-random pattern that I can execute properly.  Until that point, the setup is no better than trading random markets... There is no edge.

 For example, I was able to reverse engineer the Powertrigger Setup. But so what?  I don't have confidence in it, so it is no better to me than a random signal.