How to Identify a Trading Edge

A trading edge is what makes you a profitable trader in the markets. If you don’t know what a trading edge is then you don’t have one. If you don’t have an edge you shouldn’t be trading. Let me explain what a trading edge is and give you some examples.

What does “having an edge” mean?

If someone or something has an edge, they have an advantage that makes them stronger or more likely to be successful than another thing or person. [1]

How to find an edge in trading

In trading your profitability comes from your edge. An edge is the advantage you have over the people on the other side of your trades. You’re trading against money managers, programmed algorithms, investors, and traders on different time frames than your own. If you can find repeating market patterns you can make money by finding your own strategy that creates more profits than losses over time. This is an edge, the ability to create a system with a positive expectancy.

Let’s look at nine different types of trading edges.

List of trading edges

Trade Timing

Your entry has better timing than their exit. Your profits come from the transaction of the person or program on the other side of your trade exit. If you have a very robust strategy then most of the time the person on the other side of your trades will be losing money. However, they may still be profitable based on their original entry on a different time frame than yours. The primary principle is that you are getting into a trade at the right time when your competitors are getting out at the wrong time.

Capital

Capital is the amount of money you have, or that you can easily add to your trading account. Being properly capitalized can be an edge over those that are undercapitalized as you have more flexibility with executing your trading system properly with position sizing and risk management. Your wins will both be more meaningful and your losses more easy to come back from. You have the advantage of being able to make mistakes and have losing trades without it ruining you.

Being undercapitalized can cause a trader to trade too big and try to have big wins to increase their capital too fast and end up losing it all. Trading a system properly capitalized can be an edge both mathematically and psychologically over those without enough capital. Don’t start trading until you have enough capital to execute your trading system.

Intelligence

Intelligence for traders and investors includes not only having a high IQ but also the social intelligence to understand how others think and the emotional intelligence to manage your own feelings and ego. Creative intelligence is also important for traders so they are able to think outside the box and create systems and strategies that fit their own beliefs about the market, risk tolerance, and screen time. Being both good at math and quick at solving problems is also a must have for traders.

The right kind of intelligence is an edge in the markets over others that are not as smart as you. However, if intelligence makes someone arrogant creating a big ego and they think they know more than the market price action then you will have an edge over them if you stay humble and go with the trend of the chart.

Market Insight

If you can identify the path of least resistance on a chart and trade the trend, swing, or price range that is happening you will have an edge over all those that think they can predict the future.

An openminded view of the stage the stock market is currently in is an edge over those with strong opinions, predictions, and ego. You will follow your strategy while they will fight the market’s price action when they disagree with it.

Market Environment

If the current market environment correlates with your trading or investing system you will have an edge. Buy and hold investors have an edge during secular bull markets while permabears have an edge during secular bear markets. Trend followers make a lot of money during strong long-term trends in either direction and momentum traders make money when charts breakout of all-time highs.

When the market environment is optimal for your trading method and system you will have a big edge over other types of traders.

Luck

Traders can make a lot of money when they get lucky trading the right chart, the right way, at the right time. You can trade in a way where you can benefit from luck. The problems arise when you confuse luck with skill and end up giving back your lucky gains through bad risk management.

There is an element of luck in trading and you can optimize luck by cutting losses short and letting winners run while position sizing right.

Expertise

Expertise comes from not so much formal schooling and book learning but through your self-learning and real-world experience which gives you intellectual and technical know-how. Real intuition comes from the experience of seeing repeating patterns over and over again during many experiences over years.

Competence should come before confidence and experience with winning is the best way to gain confidence.

Status

Your social status includes your network and connections. It’s how you’re perceived. This also includes your inner status, which is your confidence and self-esteem. If you know successful traders and can call or message them with questions for advice that can speed up your development as dramatically as a trader that creates an edge through a connection. A new trader must first understand the right questions to ask and then know the right people to ask, both of these skills can be an edge.

Psychology

All of these above edges are built on the foundation of the right trading mindset, which is the one thing you have the most direct control over and where you have the most leverage. Without the right discipline, perseverance, and consistency no edge will work in the long term. The right trading psychology itself is the single biggest edge you can have as it enables the ability to build all the other ones over time.

You will have an edge over others if your trading psychology is right. If you can manage your thoughts and emotions you have an edge over all those who can’t. If you can keep your ego under control, you can take money from those you can’t admit they’re wrong. The right psychology in trading is an edge over those with the wrong psychological approach to the markets.

Now do you understand what a trading edge is? More importantly, do you have one?

Image created by Holly Burns

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