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The question of an edge

  #24 (permalink)

North Carolina
Trading Experience: Beginner
Platform: NinjaTrader, Tradestation
Favorite Futures: es
Posts: 644 since Nov 2011

Let me add a different perspective to your question, first a hard "edge" would be something that is mathematically provable. Science is based on the idea that events are repeatable: it relies on a self-consistency assumption. If for whatever reason, things are different where I sit then where you sit, science itself would break down or more specifically, the scientific method would not yield useful results. A corollary to this idea that can be found in statistics is the normal distribution which many statistical methods assume or rely on to produce meaningful results. However, markets are non stationary which simply means that there are periods of both trend and range. Truthfully, markets are chaotic in nature. A different kind of mathematics would be required to elucidate any deeper truths.

As you eluded too, there are different types of edges in the market. If my trading cost are less then yours, I have a relative edge. That translates to my making more then you --even if we were to take the exact same trades: in some cases, that could even translate to my ability to consistently make money while you could be losing money.

What most traders talk about when they talk about having an edge though is what we will call an empirical edge. It is basically the sort of reasoning where we infer future results from past results. The same reasoning is utilized by both discretionary and system traders: however, their are unique differences that are relevant. The discretionary trader may assume markets to be random, the default belief system. However, as a result positive experiences eventually the trader eventually revises their belief system based on their performance. This forming a belief system based on the evidence is known as a statistical or empirical belief system. However, due to the non stationary nature of the market, empirical results are at best a soft edge. They are not conclusive: it is not the sort of mathematical edge that a casino has. Both discretionary traders and trading systems use empirical reasoning to form their basis. Discretionary traders primarily have formed their belief system on unseen data whereas systems are primarily developed historical data and verified on unseen data. Discretionary traders will probably be using more advanced or complex models of reality. A more complex model of reality is more likely to be real but also the performance of that model is less well understood. This means more variance and there are many unknowns for the discretionary trader (style drift, execution problems, market shifts). Systems rely on highly simplified models of reality that are less likely to be real. However, the parameters are well understood.

In other words, a discretionary trader will have difficulty producing super normal returns because they do not know how precise their predictions are. A system trader will have difficulty producing super normal returns because while they know how much they can leverage their system: the cost of that knowledge is having a less realistic model.

Expectancy is merely a descriptive statistic. If you are in a drawdown, at least from the highs, all the statistics will look bad. If you extrapolate anything from that it will show that you will continue to lose but if you are up then all the statistics will look good and any extrapolation will probably be more rosy then reality.

There are different ways of thinking about trading that are less discussed but may be illustrative. These ways of thinking about trading might be best described as "cognitive price discovery" and "intentionality". I suspect that elite level discretionary traders do not think in singular terms of having an edge, that is in terms of repeatable events, but rather incorporate also the sentiment of the other traders. Cognitive price discovery can be thought of as a real-time phenomena. As a hypothetical example, a trader may short a bunch of contracts at price lows, if new lows aren't made then the trader may infer from that that there is a large buyer at price lows and thus becomes a buyer him or herself.

As for say a system traders edge, we would need to differentiate the intentional conscious process that the system developer utilizes apart from the rules driven systems themselves. We can imagine a system trader, like a fiendish demon, working behind the scenes developing new systems, tweaking existing systems, retiring systems, etc. However, if this activity is responsible for the performance of the systems then we the cause of the profits is not the rules but rather the conscious decision making of the developer, the cognitive processes. In order to see the true rules driven performance, we would need to freeze the development and run the systems over a very long time such as 10 to 30 years. If the systems frozen 10-15 years back and ran 10-15 years in the future does not show an edge or as significant of an edge then we can infer that a system developers profits aren't coming exclusively (or perhaps even primarily) from the rules driven trades but rather from the cognitive processes that the developer employs, consciousness or in other words intentionality or cognitive processes.

Last edited by tpredictor; July 15th, 2017 at 04:02 PM.
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