Last Updated on 20 April, 2023 by Samuelsson
The competition in the financial market is so high that amateurs are easy prey for market predators. So having some kind of an edge in the markets is crucial to make money. But is it possible?
Yes, you can still find trading edges in the markets, but it requires some serious work: research, brainstorming, backtesting, and optimization.
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In this post, we’ll explain what a trading edge is and discuss how you can find one.
What is a trading edge?
A trading edge is an inefficiency you identify in the market, which can be exploited with the use of a suitable strategy. The edge is based on something that shows better returns than the average. It is something that gives you an advantage over the other players in the market, as you need to separate yourself from the other traders in the market if you want to make money.
The edge is what you develop into a trading strategy by formulating the entry and exit criteria, as well as risk and money management parameters, so it is the core of your strategy and where you start when backtesting strategies. With that core, you can further employ exits and other tactics where you know you have some statistical possibilities of generating profits in a process referred to as optimization.
The website Quantified Strategies has launched an interesting service called Trading Edges where they monthly publish an edge, mostly on ETFs.
Trading edge vs. trading strategies
As you see, an edge is not the same as a trading strategy, but rather, the raw material for it. A trading strategy is a complete set of rules that guide your trade entry and exit, as well as intra-trade adjustments, such as trailing profits and partial exits. The trading strategy also contains elements of risk and money management rules for each trade.
Since an edge is something that deviates from the averages and has the potential to become a complete strategy, it is an excellent starting point in the process of developing a complete strategy, which includes backtesting and optimization.
Some examples of an edge include:
- Mean reversion in stocks
- The end of the month edge in S&P 500
- The momentum effect
To turn mean reversion to a strategy, you will state the indicators and the entry and exit rules.
How to find trading edges
It is not easy to find trading edges, as traders are too secretive to ever share whatever they have discovered in the market with others. But you don’t blame them, because when a strategy gets too crowded, it inevitably loses its edge and becomes useless. So, you will have to find your own edges and develop your strategies yourself.
These are some of the ways to find a good trading edge:
- Do your research: Some financial market publications discuss some market inefficiencies in the form of research articles. While most of the research publications may be boring to read, many trading websites break them down into trading edges. Some of them require a paid subscription to access, but they are well worth their money. However, don’t expect any paid service to do all your thinking for you. Use them as a starting point and build on the ideas.
- Interact with other traders: Two good heads are better than one. We have been profitable for many years, but one of the main reasons for our long-term success is interacting with other traders and sharing ideas. No one can possibly generate enough trading edges on their own to stay profitable for a long time. One way is to be active on discussion forums and share ideas with other traders. When you’re helpful to others, you will get help in return. You could also pay for one-on-one learning with traders you know have been successful in the past.
- Brainstorm ideas: Sometimes, you have to brainstorm to generate ideas. Some of the ideas might not make sense initially but would be profitable when tested. Ensure you write down your ideas and test them later.
- Take a walk: If you find it difficult to brainstorm on your desk, take a walk. In fact, walking frees your brain from the mental fog that comes with staring at the screen all day so that you can think clearly to generate fresh ideas.
- Have a systematic approach: When you get ideas, write them down and test them one after the other. Be sure to keep a record of all the strategies you have tested because you may find them useful later on. You might only need to make a little modification, and you have a great edge.