Finding a Trading Edge That Holds Up Over Time, in Any Market

NEW YORK (TheStreet) -- Do you have a trading edge? If not, how do you go about getting one?

The market is a tough place to earn a living, with the majority of profits going to a minority of traders. Members of this elite group have one thing in common: They all trade plans with proven edges. It's often self-taught because well-known strategies encourage a huge crowd to trade in a specific way. The sheer number of participants ensures the methodology will carry no tradable edge at all.

Contrary to popular opinion, basic technical analysis offers little or no edge to traders. But don't dismiss this valuable tool just yet. Buried between the lines of your favorite patterns and indicators are unique trading styles and methods that work well in the long haul. You can access these power points by getting a basic education and then setting off on a personal journey that fully explores TA's day-to-day applications.

Take a few steps down this path and then build your own set of observations about market dynamics. Catalog the moves that catch your attention and deconstruct them. How did they start and how did they interact with the chart? Have you seen this type of behavior before and, if so, what happened next? What kept you out or got you into the trade the last time? These small Q&A sessions can become the basis for building a lifetime edge.

Trading with an edge requires a mental process that looks like intuition, at least from the outside. Profitability comes when we act naturally on analogs to patterns and situations we've already experienced. This accumulation of knowledge lets us act spontaneously as the environment changes, with the sum of our observations and recognition of past mistakes forming the basis of our profitability.

Simple preparation and adequate tools give traders a minor edge over those less prepared for the market day. A real-time quote system and fast execution will pick the pockets of those who are stuck with high commissions and slow terminals. But technology can't turn a bad trader into a good one or help you find an edge that fits the way you play the game.

Position management gives traders an important edge because it takes their rules and turns them into actions, but it only works when it skews characteristics of risk and expectancy in your favor. In other words, it needs to increase your profits on good trades and reduce your losses on bad ones. This requires a solid understanding of leverage and position sizing, which is a lot harder to master than it looks.

Awareness of entry and exit pricing defines a trader's edge better than any other technique. This attention aligns perfectly with the position outcome, but it's not as obvious as it may seem. Many traders get fixated on the big picture or underlying trend rather than the specific levels that yield profit or loss, while those who focus ruthlessly on entry and exit are more interested in making money than being right.

Many traders look for their edge in mechanical systems. Institutions use complex automated systems with great success, while a select group of at-home players uncover useful edges through back-testing programs such as TradeStation. Even so, most participants should stick with discretionary trading based on our own set of rules. Realistically, this requires a heavy dose of personal responsibility because there's no one to blame except ourselves if we're in the hole at the end of the day.

Many traders who think they have a valuable edge have none at all or one that won't stand up to the test of time. For example, the buy-and-holders who ruled the 1990s and the middle of last decade lost their edges as soon as those bull markets ended. The tough lesson addresses the most important aspect of a trading edge is that it must hold up over time and through most or all market conditions.

Each day, Alan Farley delivers strategies and trades designed for a roller-coaster market in Daily Swing Trade. You can get a free trial here.

 

 

Alan Farley is a private trader and publisher of Hard Right Edge, a comprehensive resource for trader education, technical analysis, and short-term trading techniques. He is also the author of The Daily Swing Trade, a premium product from TheStreet.com that outlines his charts and analysis. Farley has also been featured in Barron's, SmartMoney, Tech Week, Active Trader, MoneyCentral, Technical Investor, Bridge Trader and Online Investor. He has written two books: The Master Swing Trader and The Master Swing Trader Toolkit: The Market Survival Guide, due out in April. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.

Farley appreciates your feedback; click here to send him an email. Also, click here to sign up for Farley's premium subscription product, The Daily Swing Trade, brought to you exclusively by TheStreet.com.

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