Understanding your edge

Understanding your edge

It’s no secret that in order to be sustainably and consistently profitable. You need a mathematical edge in the market. At the core of your edge 1 important rule should never be broken. If it is, it essentially means you don’t have an edge. 

The sum total of your winning trades, needs to be greater  than the sum total of losing trades plus the cost of trading. Over and above your losing trades your winning trades need to pay for your cost of trading. These costs may include but not limited to.

Subscriptions to charting platform.

Broker monthly fees.

Data feed

Books 

Courses etc. 

Having an edge isn’t enough. Being disciplined and making sure that you take every trade your edge produces. That’s more important than the criteria your edge uses to define a trade. 

You also need to intimately understand why, what you define as an edge would be profitable. Understanding your edge helps you manage your excitations in different  market circles. You get this intimate understanding through back testing and actually trading it for a long enough period. Remember you can’t back test your emotional reaction to a run of losing trades. You also need to test it with actual money.

When you intimately understand your system/edge. It’s easier to stay with the system during tough periods. Every system in the world goes through a tough period from time to time. If you remain solvent through the tough time. You will be available for the times your edge actually plays out.

I’m a long only trend trader, and I trade continuation breakouts. I trade mostly stocks with a small dash of vanilla equity indices. Which means during a bear market I’ll be sitting in cash. When the market trades in a range, with frequent false breakouts. I’ll be losing money. I’ll only make decent money in a bull market. And that’s fine.

Why would my system make money? Because when I buy a stock I only exit when I’m stopped out. It means in a strong bull market my winners are going to be significantly greater than my losers would be in any market circle. Not only do I let my winners run, I add to my winners as well.   Because of that I don’t stress over losing money in a  sideways or a bear market. I know my day in the sun will come eventually, because markets will eventually trend.

When I add to my position this is my checklist

  1. Valid signal
  2. Stop loss of the new trade is higher that the current one.
  3. Risk to the trade remains less than 3% (2% on the trade 1% accounting for slippage)
  4. The current trade has to be in profit
  5. 200d EMA is behind me 
  6. 50d EMA (not mandatory but preferred)

Basically my system tells me, to quote Richard Dennis “This structure means up, this structure means up no more. Never that this structure means this much and no more.”

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