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The question of an edge


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The question of an edge

  #21 (permalink)
Johno1
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geth03 View Post
i think i can call myself a full discretionary trader, which means the only tools i use for my trading is the Depth&Sales in futures trading and MarketMakerBox and Time&Sales in stocks trading. i watch the play between buyers and sellers and make my final decision on which side has control. Eg in a range we see buyer aggresiveness from support to resistance. then the price comes back to support bc buyers are loading up and dont want a breakout at this moment and sellers are not quite aggressive, price chopps back to support. finally buyers become more aggressive and breakout of the range. how do you want to backtest this? you can only gain this knowledge by watching the time&sales for monthes. how do you want to backtest fake orders on the order book. offer is pumping up and the same guy loading on the other side. no way to backtest it. you see it you join the party. if it goes in my favor i make 5 times more than it goes against me. there is no way you can backtest these things. i use highlowclose bar charts only to identify interesting price levels and thats it. and. to identify the market structure.


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In a nutshell, the art of successful trading is to define who is in charge and to then jump on board. as long as your winnings exceed your losses you survive. You don't need an arsenal of tools, just your eyes and your brain, so many people are baffled by the bullsh-t.

Cheers cJohn

"Simplicity is the ultimate sophistication" Leonardo Da Vinci. Now there was a man who knew a thing or two about creating masterpieces.

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  #22 (permalink)
 GFIs1 
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To refine my previous post of today:

There are systems that work quite well over some time.
Reaching the "end of consumption date" this system might no longer work.
Really?
Yes - really - POINT.
Depending on market conditions - some back and forth tested systems are
going the normal way of life: DOWN

Just be aware of this and test some other genius (bar) systems that might
have success.
Never be sure to have the holy grail for more than 1 year

The only thing that can make us optimistic:
The market will be here tomorrow again

GFIs1

If you are not sure - then watch @ratfink threads here who is telling you the truth
about finding the edge and about exquisite results - sometimes in sweat. Cheers!

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 ratfink 
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GFIs1 View Post
... exquisite results - sometimes in sweat. Cheers!

It's been a long time since my exquisite Sprint results, now much more like exquisite beer and sweaty results...

Cheers

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  #24 (permalink)
 tpredictor 
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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.

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  #25 (permalink)
 Grantx 
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@kevinkdog Ive had a brief look at your AMA thread and you are primarily focused on algo systems. I don’t know much about your world so correct me if Im wrong but that requires a completely different mindset to day trading? You will have a variety of different strategies simultaneously working across multiple timeframes and instruments? You closely monitor expectancy and adjust your ‘worker bees’ when one underperforms? Expectancy is the single most important thing to you because it is the only way to gauge the performance across tens or hundreds of concurrently running algos?

I see now the importance of expectancy however as a day trader I just cannot accept that expectancy is at the top of my hierarchy of needs. Day trading requires that we constantly monitor ourselves and every possible direct and indirect variable that could affect our decision making ability. The food we eat, how much sleep we have had, what mood we are in, money mgmt, FOMO prevention etc..all contribute to how effectively we can execute our trade plan at go time. You can be amazing one day and the next day it’s all gone to shit because one of the parts where discipline slipped spiralled out of control causing a chain reaction. Think Jesse Livermore,

A day trader must monitor all aspects of themselves at all times just the same way that you monitor your algos expectancy at all times. In my world there is not one thing whos importance overrides all else. Expectancy will tell me how well Ive done to date but tomorrow is another day and if Im disciplined in all areas of my approach then I can maintain a positive expectancy.

--------------------------------------------------------------------------------------------------------------
For the benefit of anyone reading this, who like me was clueless to this very important metric (but thankfully am now fully aware of it), I have been doing some reading and the following is a basic intro on what you need to do. You should try and get as big a sample size as possible, a few hundred trades minimum if you can.

You only need 4 pieces of information:
1. number of winning trades
2. number of losing trades
3. amount of money won
4. Amount of money lost.

From this data we can calculate the following:

Net profit = amount of money won - amount of money lost
Win rate = number of winning trades / total number of trades
Lose rate = 1 - win rate
Average winner = amount of money won / total number of winners
Average loser = amount of money lost / total number of losers
Average reward / risk = average winner / average loser
Expectancy per trade = win rate x average winner – lose rate x average loser
Or, alternatively, expectancy per trade = net profit / total # trades
Expectancy per month (profit forecast) = expectancy per trade x average # trades per month
Expectancy per amount of money risked = win rate x (average reward / risk + 1) – 1
Or, alternatively, expectancy per amount of money risked = net profit / average loser / total # trades

Here is an example:
Lets assume we have been trading for 6 months and made a total of 540 trades. 297 of them were profitable and 243 were not, with $35.640,00 profit coming from the winning trades and $19.440,00 loss stemming from the losing trades. Lets make the calculations:


Net profit = $35.640,00 - $19.440,00 = $16.200,00
Win rate = 297 / 540 = 55%
Lose rate = 1 - 55% = 45%
Average winner = $35.640,00 / 297 = $120,00
Average loser = $19.440,00 / 243 = $80,00
Average reward / risk = $120,00 / $80,00 = 1,5
Expectancy per trade = 55% x $120,00 – 45% x $80,00 = $30,00
Or, alternatively, expectancy per trade = $16.200,00 / 540 = $30,00
In our example the expectancy per trade is $30,00. This means, on average (over many trades), each trade will contribute $30,00 to the overall P&L.

Expectancy per month = $30,00 x 540 / 6 = $2.700,00
In our example we can forecast a monthly profit of $2.700,00 based on prior performance.
Expectancy per $ 0.61% risked = 55% x (1,5 + 1) – 1 = 38%
Or, alternatively, expectancy per $ 0.61% risked = $16.200,00 / $80,00 / 540 = 0,38

Credit to JasperForex on tradingView for allowing me to reproduce the breakdown above.

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 ratfink 
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Grantx View Post
A day trader must monitor all aspects of themselves at all times; just the same way that you monitor your algorithm's expectancy at all times. In my world there is not one thing who's importance overrides all else. Expectancy will tell me how well I've done to date, but tomorrow is another day. If I'm disciplined in all areas of my approach then I can maintain a positive expectancy.

Numero Uno.

Great post, this is a good discussion for all of us.

For the record a good while back I did 2100% in 3 months with 177 discretionary five minute binary trades with a win rate of 67%, so I figure the expectancy was decent, maybe even 'super normal'. Then I blew it up because I went all experimental and failed completely on Numero Uno.

The two cannot be separated and I am still trying to recover from the divorce. Expectancy on its own means nothing if you are stupid with leverage or cannot control the inner forces.

Cheers

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  #27 (permalink)
 
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 rleplae 
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Interesting to see, at the same time

1) how 'hot' this topic is
2) how difficult it is to 'articulate' what is the edge...

I think this is exactly what separates retail from professional world...
it would be worth a seminar and for sure more than a few hours can
be filled on this topic...

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  #28 (permalink)
 
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 SMCJB 
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rleplae View Post
Interesting to see, at the same time

1) how 'hot' this topic is
2) how difficult it is to 'articulate' what is the edge...

I think this is exactly what separates retail from professional world...
it would be worth a seminar and for sure more than a few hours can
be filled on this topic...

I agree. Well said.
Part of the issue is that edge and expectancy mean different things to different people, and in many cases aren't transferable.
To HFT it might be speed.
To Kevin it may be systems with high expectancy.
To a market maker or a prop customer desk it could be flow.
To somebody else it may be knowledge or information.
To yet somebody else fundamental analysis.
The list is endless.
The bottom line though is that unless you have a reason to believe you will make money, why would you do it?
That reason whatever it is, is your edge, however you define it.
Expanding on what somebody said earlier, if you dont know what your edge is, chances are you don't have one, which probably means you won't be trading long - at least not profitably.

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  #29 (permalink)
 tpredictor 
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And, it should be noted that for many capital itself is an edge. Capital to deploy different types of strategies and even capital to trade in the first place. In fact, if we accept that capital is required to trade, we can logically see that no trader has ever made money exclusively from trading. A trader might say, for example, he doubled his 5k account. But where did the original 5k come from? Because capital is required to trade, we can see that at least a significant edge for all traders must have been acquiring some capital to start with. Basically, no one has ever made anything from trading ability alone: capital was required.

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  #30 (permalink)
Johno1
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tpredictor View Post
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.

What a great post!

You have summed up the core challenges in successful trading. The markets are constantly evolving and therefore constant adaption is required, here lies the problem with the rigid rules usually found in Charting and TA (Systems Trading). Price doesn't always reflect the true nature of the market, so where is the reliable edge in Price Analysis?

We all trade a system even if it is as chaotic as flipping a coin. If you are constantly adapting your system (hourly/daily because this is how quickly the core market dynamic changes) to suit market dynamics then you are a Discretionary Trade.r As a successful Discretionary Trader my observations are quantified thru spreadsheet formulas and analysis, so there is a technical aspect but that takes second place to getting and staying as close to the market leading edge as possible.

The nature of the market itself, not the system must dictate what we do.

Cheers John

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