Edge is what keeps you a step ahead of your competition. It’s the keys to your Ferrari, your Spanish villa, your drive to be just that much better than everyone else, and your ability to succeed when those around you can’t help but fail. Edge is what gives you your positive expectation for your future returns.
Over the past twenty plus years of trading, I have learned a thing or two from being in the ring. There are a few things that separate the great successful traders from the ones that have experiences similar to the wrecks witnessed at the Daytona 500. The vast majority of successful investors that I have worked with have exploited some form of edge, and they had it coupled with sound money management skills and discipline. Through hard work and methodical application of their edge, some have created tremendous wealth. Before we go into detail, I would like to share my story on how I became aware of the importance of edge in successful trading.
Many years ago, when I was a young, aspiring trader and a member of a high flying CTA, I was made aware of a fundamental misunderstanding I held about trading. We had several years of terrific performance and were garnering a great deal of attention. Several of the biggest names in the business were calling and coming in to meet with us. We were in Southern California, and while the majority of the US was in the middle of a difficult winter, they needed little excuse to come down and have a warm relaxing weekend. We were it. Most asked the standard questions about our models, the markets we traded, money management, risk controls, and general operations.
During one of my meetings, I had a very enlightening conversation with a large fund manager that helped me in my understanding of making money from trading the commodity markets, as well as all of my investments. He simply asked me, “what is your edge?”
You see, before this conversation, my only thought was, “can I possibly make money?” instead of, “why do I expect to make money in the future?” You see, these are two completely separate ideas. Making money on a trade today has very little correlation to making money over time.
What is my edge? Why do I expect to make money? After all, the market does not exist to hand out money. Every investor must find his edge, or a way to obtain an edge, if he wishes to make positive returns over the long haul. There is not just one way to develop an edge. It can be as unique as the traders who have found ways to exploit their own edge. However, there are general trading characteristics that most traders use to create an edge. Trend-following and computerized models are used by many of the largest and most successful trading firms. They allow investors to capture the major price trends created by supply and demand imbalances in the financial and commodities markets. Premium, or ‘volatility selling’, is also a primary investment tool. The selling of options allows traders to capture time decay and take advantage of mispriced volatility, and can be used in conjunction with other methods. Other successful traders have Technical and/or Fundamental expertise. Fundamentalist tend to be specialist in a market sector and understand the many nuances of information that drives their particular markets. Technical traders have expertise in analysis of price action and the signals it gives.
Traders need edge to win, but edge by itself can still leave an investor broke. In addition to edge, investors need proper capitalization, discipline, and, most of all, money management. Risking too much capital on any single or series of trades can destroy the best trading scheme. Not completely following your trade plan can also do the same damage. I will be going over many of the forms of edge, money management models, and things I have learned in future articles. Stay tuned and feel free to contact me if you have questions or comments.
