Building and Refining Your Trading Edge

It’s simple – if you don’t know what your trading edge is, then you probably don’t have one.  If that’s you, then you are basically a gambler because you’re most likely allowing the market to hold the edge and are hoping you can beat the odds.  Even if you get lucky and start off strong in your trading career, the combination of a negative trading expectancy and limited equity means that the market is probably going to win in the long run.  If you’re serious about making it in this business, this isn’t the kind of professional approach you want to have.

On the other hand, being a trader is all about having a structured and profitable methodology where you know your edge in the market exists through both historic and real-time testing.  The trader knows he has a winning edge as long as he sticks to his plan and executes with consistency.

An elite discretionary trader also realizes that his edge is more than just numbers and statistics, but also includes his mental approach to trading.

 

Your Trading Edge Sword

Defining Your Trading Edge

So to start, how do we define our trading system’s edge in the market?  If we don’t have clearly defined rules for our trades and some data to support them, then we simply don’t have an edge we can rely on.

Building an edge comes through a combination of research and extensive testing.  After some initial inspiration gives you an idea for a setup you can potentially integrate into your trading plan, the next step is putting some rules around it.

What needs to be present for this setup to be valid?  In what situations should you NOT take the setup?  How will you exit the setup if it succeeds or if it fails?  The second question in particular is often neglected when it comes to system development.

Once you’ve got your rules, it’s time to test and test some more.  Traders are very lucky these days because trading platforms such as NinjaTrader have robust replay and simulator functions built right in, so use them to your advantage!  Run through some historical data and do everything possible to approach it the same way you would if the market was real-time and you were trading with meaningful size.  When a valid trade comes up, don’t hesitate, TAKE IT!

If it wins or loses, don’t worry.  It doesn’t really matter what the outcome of that single trade is.  

Even with a strong edge, a single trade always has a random outcome and even the highest probability setups can and do lose.  In order to really know if what we have is a statistically significant edge, we need to test more than just a small handful of trades.

You should look to test at least 20 trades (near the minimum for statistical significance) that fit your setup criteria and then sit back and take a good look at the numbers.  Is the edge strong with an excellent positive expectancy (risk to reward combined with win percentage)?  What about after factoring in trading costs?  If everything looks good, it’s time to go to the next step… testing some more.

Yes, I realize that all this work isn’t exactly the “sexy” part of being a day trader, but in order to build confidence in one’s edge there must be a lot of data to back it up.  So repeat the tests of 20 trades using different historical data at least twice more.  If you have run things through 3 times and all of them have shown that your setup has an edge that is substantial then you can take things to the next level, which is live trading.

This step takes a bit more time, because you need to wait for your tested setup to come up at least 20 times in live markets.  Keep trading the way you did using your historical data, and don’t start to become overly conservative or aggressive just because you are now live.  This is actually a common mistake made by many novice traders, but if you don’t trade the same way that you test, what use is all that data?

If you’ve made it through 20 live trades with your setup and you still have the same solid edge then congratulations, you’ve just added a new setup to your daily trading plan!  

You now have the confidence both historically and in real-time that this setup will make you money over a set of trades.  That is extremely powerful and automatically puts you way ahead of 95% of the traders and gamblers out there who don’t put forth the effort to rigorously test their trading plan.

 

Confidence in Your Trading Edge

Confidence in Your Trading Edge is Vital

It’s vital that any trader has full confidence in the ability of their edge to provide them profits over time.  Without this, a trader becomes far more susceptible to breaking their own rules and making foolish trading decisions.  In order to have this confidence, we need two essential things.

The first is the large sample of trades we discussed above that cover both historical and live markets.  With a statistically significant sample that has been properly tested we can be confident in our positive expectancy over a large set of trades.

The second crucial factor in that we have the ability to properly EXECUTE that tested edge.  Just because we have a tested trading plan doesn’t necessarily mean that our success is guaranteed.  We need the patience and discipline to wait for the setups that fit our plan and we need to be able to be fully prepared to enter the market when the moment presents itself.

Adding this mental edge to our tested system edge is what truly separates the traders who just get by from the ones who have truly elite performances week after week and month after month.

Patience is the Key

So how do we build and refine the mental aspect of our trading edge?  In this case, there are few short-cuts.  It simply takes time, discipline and the desire to continually improve!

If you are at this point, you’ve hopefully done all the testing necessary to have confidence in your various trading setups and your overall plan.  All you need now is the patience to wait for those setups to appear.

Most people enter trades based on emotion - greed and the fear of missing out – but true traders enter the market based on their EDGE.

As day traders, we have a unique advantage in that even when trading with discipline and patience we can still see plenty of trades within a single day.  In many ways, swing and position traders actually have the more difficult job as they sometimes have to wait days or even weeks for that “ideal” trading setup that fits their rules.

This quicker time-frame makes it much easier for us to keep our discipline and wait for the high quality opportunities that maximize our expectancy and overall profits.  The key here is to have patience – don’t go frantically searching for trades and voluntarily allow your trading edge to decrease.  Sit back, assess the market with clarity, and attack only when your trading edge presents itself and the odds are stacked in your favour!

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About the Author

Cody HindFounder & Head Trader of Samurai Trading Academy. Cody has almost a decade of day trading experience in the Emini S&P 500 futures and Forex markets. He has also coached dozens of traders, helping them to achieve their financial goals.View all posts by Cody Hind →

  1. MarkMark08-07-2013

    good article bro, i hope people take note as its key to success on the live side of the market

    • Cody HindCody Hind08-18-2013

      Thanks Mark! That means a lot coming from you. Unfortunately, a lot of people won’t want to do the hard work and testing to really define their edge, but that’s all right. We need to make our money from someone, right? ;)

  2. CarreraCarrera08-11-2013

    Fantastic article, my friend! This is the sort of stuff that separates those who really make trading work from those that never will. Keep them coming!

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