Three simple ways to gain an edge in trading

The other day Nick Maggulli @dollarsanddata who runs a wonderful and always insightful financial blog of Dollars and Data wrote a piece called a “Stock is not an Index in which he pointed out that if you owned an S&P 500 index fund you would be assured of outperforming 80% of all investors whereas if you you owned just one stock - not so much.  

The reason of course is clear. An index is a dynamic list that changes constantly based upon the various selection rules of the S&P committee whereas a stock is a single static business entity that may thrive or fail miserably based on a myriad of idiosyncratic risks. Of course you may get lucky with a stock - you may have chosen Google or Amazon in early aughts and outperformed the broader market by a wide margin. But what are the odds of that?  Put simply, the question you want to ask yourself is what would you rather have in 30 years - a near 85% certainty of one million dollars in your retirement account or one in a thousand chance of making five million dollars but a fifty percent possibility of having no retirement funds whatsoever. (Those aren’t real odds because no one can predict the future, but they are a close enough approximation of what happened over the past two hundred years of investing).

The index vs. single stock investment is an example of a simple market edge that could have literally life altering consequences if you chose incorrectly.  Many such simple edges exist in trading as well  but most of us roundly ignore them.

One obvious edge in trading is to widen your stops and targets and lower your leverage. I’ve moved away from trading forex - but recently just for s-ts and giggles I’ve started to post on Twitter a few select trade ideas that I put into my personal account once or twice a week. Since I am very busy running BK and day trading equity indices I’ve moved to a simple 100 pip stop 100 pip target in my FX trades using very low starting leverage to ensure that I have plenty of capital to adjust my positions. I do this frankly because I don’t care about FX and I don’t have the time or the desire to follow it closely but the irony of course is that my FX trading has never been more successful as the wide stops avoid the endless intra day churn outs and the low lever factor allows me to size up modestly and bank fresh profits on any follow up trades I make.

Yet another simple edge in trading that very few retail traders employ is to automate as much of the trade execution  as possible. I have a day trading system that I trigger manually, but after that the  algo does all the work. The automation makes sure that I have the right instrument, the right size, the right stops, the right exits and most importantly the right entries for the full trade cycle strategy. It does all the clerical work while I am sleeping, or walking my dog or eating lunch or just wasting time watching YouTube videos.

It’s amazing how much better my trading has been since I actually stopped... trading.
And that is what edge is all about.

Edge in trading doesn’t come from your brilliant technical analysis or fundamental insight. As one old time trader used to tell me, “Opinions are like a-holes - everyone has them.” Every single trade idea in the world, no matter how complex or simple, can be reduced to just two primary concepts - continuation or reversal. The value of analysis is grossly overblown. Rather, an edge in trading comes from eliminating mistakes. Eliminating mistakes comes from eliminating decisions. The less decisions you have to make manually, the more edge you will likely have. Just as Mr. and Mrs. Main Street trounce almost every hedge fund manager in the world by buying an index fund and making  no decisions whatsoever; traders who make fewer decisions will likely outperform those that make many. 

Of course that’s not a hard and fast rule. Trading is an extremely personal endeavor and works best when you trade to your personality rather than some system forced upon you, but regardless of whether you are a degenerate day trader like I am, or a thoughtful and patient investor like my wife, the edge always comes from doing less than more.