Monthly Archives:September 2015

Edge, Not Direction Is The Basis For Strategy

littl121 post on September 29th, 2015
Posted in Trading Tags: , , , , , , , , , ,

Oft times I am asked where a particular currency is headed. My usual answer – I am a short term trader and have little grasp on forecasting currency direction. Some are smarter and ask whether they should buy or sell a particular currency. My reply – both are acceptable, insofar as they have identified a buy edge or sell edge before jumping in.

Which brings me to the point – a trader does not trade direction, he trades the edge.

This is not to discount direction, but with crystal clear thinking, direction is just the result of an edge in action. (What about momentum? Momentum is a bit more complicated, and can be used as an edge or be a mere spectator by-produce. But more of that next time.) So a trader can buy the US Dollar or sell the US Dollar, it does not matter if he has identified a worthy edge when he buys or shorts the currency.

Normally when I develop a strategy, I identify the possible edges, and then construct the most proficient set ups I can to take advantage of those edges. Conversely, if a set up appears, I want to know if the edges are in high probability play. Some traders advise when a set up appears, one must take the trade regardless how he feels – since emotions can convolute judgement. By all means, if that works for you, go ahead. That edge may lie in success based back testing, position sizing, continuous trend run and so forth. Truly, there are many ways to successfully skin a cat. Knowing how unpredictable the market can be, I be a fool to claim otherwise, and am merely sharing what I know works for me. But whatever method a trader employs, he must always be able to see the edge in what he does.

This passage may appear fuzzy and incongruent to some. It is not by deliberate effort or accidental thinking that I wrote in such manner. Either the reader understands or does not. If he does not, then he requires more screen time and reflection – truly that is the secret of seeing where the edge lies.

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Many Markets Many Opportunities

Should we trade just one or many markets?

The more able and ambitious the trader, the more markets he can trade to maximize his returns whilst minimizing risks.

Let’s get this out of the way – this is NOT a version of portfolio theory for maximizing returns through effective differentiation. Elegant as the mathematics may be, the Nobel laureate himself pointed out the model’s effectiveness was predicated on assumptions made about the performance of assets being admitted into the portfolio – ie. the objective mathematical mechanics are run on subjective persuasions.

No – trading multiple markets simply means picking and choosing opportunities with the best trends and trading the motivations behind the strongest moves.

As an example, an event may happen in the equities market that also influences the commodities and FX markets (such as a Chinese market meltdown). The world runs into a risk off scenario, and the severity of the equities market weighs on other markets. But due to the vagaries of the commodities and FX markets, their price movements are not as directly correlated to the unfortunate event. Though pervasive pessimism sweeps all the markets, their trends may be less predictable and vitriolic. The stress behind the equities market thus offers a more direct, stronger trend than for commodities and FX markets. Another example is the sustained oil price slump. Even when it was possible to trade the Aussie and Canadian dollars, it would have been more rewarding and less pressurizing to trade the fall in oil price directly, than weather interim whipsaws in the FX markets provoked by Yen, US and European currencies.

So is a choice of multiple markets naturally better for the trader? The caveat is the trader himself must know how to trade different markets well. He can achieve this through diligent appreciation of various markets’ characteristics or by employing various trading solutions. If the trader lacks such motivation or abilities, it is better for him to trade single or fewer markets. It will not be as efficient, but at least he can still be reasonably profitable. For someone who wants more bang for the buck, multiple markets and multiple timeframes is the way to go.

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