Why knowing when not to trade is an edge
|Traders want to trade. That’s what we feel is our job and that’s when we feel that we’re actually really doing something. And I think that’s why it can be so tough to go through periods of low trade frequency. It just somehow doesn’t feel right. Might be missing out on something. For sure the markets keep on moving and others are trading, right?
But feelings are often misleading, especially when it comes to trading. The fact is that to know when to not take a trade is as important as to know when to put on a trade and be active in the markets.
Mechanics of a Valid Trading Edge
Whatever approach you’re using to trade in the markets, there is always a time when that approach will actually not give you an advantage in the markets.
That’s why most trading systems have some kind of a market regime filter that defines when to actually follow a signal or not. That filter might measure volatility, check if there’s an up- or downtrend going on or look for periods where the market is not trending at all. Other kinds of filters are limiting trading to certain trading hours or specific weekdays or certain regular news events.
Without these filters, without these periods of standing on the sideline and not trading, it’s very hard to make money in the long run. As whatever money you’ve made during the time when the market was in sync with your trading style, you’ll probably give most of it back if you stubbornly keep on trading when the market is not. One exception that comes to my mind is long term trend following where you simply cannot afford to ever miss a trade and where filtering trades can be very expensive.
But in general, knowing when not to trade and then do exactly that is actually an edge. If you keep on trading all the time, you will on average lose money during these periods where you should not trade. And to avoid a losing trade is at the end of the day as good as having a winning trade. The only difference is that it just doesn’t feel that way. Taking a trade and making $1000 feels like you did something, you see that trade on your daily account statement. If you skip a losing trade, you might not even notice that you just saved yourself from a $1000 loss, and it actually doesn’t even show up in your trade history. Still, you now have $1000 more than you would have otherwise. So remember that and be patient during times of low trade frequency.
Happy Trading!
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