Trading advantage is a technique, observation or method that can create a cash advantage over other market participants. It does not have to be carefully designed to achieve its purpose; anything that adds a few points to winning the equation will create a lifetime advantage. If you haven’t found it yet, don’t be frustrated, because most traders don’t even know it exists. This is the main reason why a few people have made huge profits, while others are struggling with weak or negative returns.
There are many ways to build a trading advantage, but we will focus on one way to use the technical skills you have already learned. This is a simple process that uses established strategies and adds detailed rules to filter out the most potential candidates, focusing your attention on the most promising opportunities. Then, it introduces a second set of rules for your trade management, seeking the maximum profit from each winning position.
A quick reality check will tell you whether your trading strategy has definable advantages. List the most common methods you use to find new opportunities, enter and exit positions, and manage risk. Then try to remember where you learned these specific concepts, whether from books, websites, or other traders. Finally, consider how many other market participants are using the exact same strategy, usually at the exact same time.
Through this self-reflection, most traders will quickly realize that they have become lemmings, using the same strategies as most market participants to open positions and manage risk. When you become a member of this group, there are two reasons why it is impossible to make a reliable profit. First, you have to compete with all these people for the same pot of gold. Secondly, the crowd will attract unnecessary attention from other traders. They notice the liquidity pool and execute predatory strategies to get rid of the weak.
The sheer number of participants acting in the same way eliminates the advantage that makes these strategies work in the first place. But this does not mean that you need to give up the trading and technical analysis skills that you have spent a long time learning and mastering. In fact, the boundless strategies that are popular in books and websites are very effective and can be used as the cornerstone of building more powerful technologies that will maintain their advantages throughout a lifetime.
Edge of time
The market is constantly changing, creating and destroying trading advantages that take advantage of the complexity of the current cycle.The trick to these time edges is to use them aggressively until the crowd shows up, then step back, and only use them when other people are leaning in the wrong way. “The “buy on dips” strategy was very popular at the turn of the century and after the crash in 2008. It is a classic time advantage and failed miserably under more challenging market conditions…unless special rules are applied.
Regulations and technology also give way to time advantages. The rise of high-frequency trading (HFT) is a good example. Previous generations enjoyed similar advantages in bullet trading and secondary scalping. System traders have an advantage over free traders with these highly technical strategies, but their advantage is undermined by excessive reliance on backtesting results that cannot explain market vitality.
Create your own edge
Just like the concept of boundlessness in books and websites, time edge provides the basis for more powerful strategies. To show how this works, we will adopt a “buy on dips” strategy and apply special rules to determine that crowds are unlikely to join our entry price. If we enter prematurely, it is easy to be eliminated, so our main task is to determine the narrow level where the reversal probability is very large, and we can confidently use the tight stop loss. Then, if we can replicate the results in multiple securities in different markets, we have overcome the time disadvantage and identified a trading advantage that may last a lifetime.
We apply the concept of cross-validation to our “buy on dips” scenario, looking for as many technical reasons as possible to turn our security to a narrow price level. The more cross-validation points we find, the more likely the level will stop falling as expected and trigger a rebound. If we cannot find at least four cross-validation points, we will give up this opportunity. Finally, we will apply opportunistic management rules to book the maximum profit, which usually means taking advantage of the crowd after they see a rebound and jump in blindly.
iShares Dow Jones U.S. Real Estate Index Fund ETF (IYR) broke through the three-month pattern in November and also completed a longer-term breakthrough. The rally stalled at a 6-year high near $78 and formed a rectangular pattern above the new support. The fund collapsed after nearly three weeks, infiltrating new support but not breaking it, providing the first verification point for our strategy. The breakout gap (red circle) on November 21 was filled, and the price landed at the support of the 50-day moving average, adding the second and third cross-validation points. This level also marked a breakthrough of the 0.786 retracement of the swing, adding a fourth point, while the stochastic indicator fell into a deep oversold level, marking the fifth clue that the rebound will begin between 75 and 75.50.
Finally, the downtrend closed near the 60-minute 200 moving average, which was a classic turning point for a callback in an uptrend.
The price structure and seasonality further increase the possibility of our professional bargain trading. The people who missed the breakthrough entered the positions within the rectangle, and these positions then became the targets of the segmentation, but we are implementing a strategy that benefits from their pain and provides us with a lower entry price. And because they are sold at the same time we buy, we are unlikely to be a target for predators. Seasonality comes into play, because the collapse occurs during the expiration of the options, which plunges the fund into the popular 75 strike, forcing the pool of open positions into worthless positions.
Now we use our advantages to find a fruitful exit, hoping to take advantage of the crowd again. There are two potential exit points, one at the previous high near 79 and the other at the upward trend line near 80. Exiting to the previous high provides the safest route, as this is where the seller may trigger another reversal. Our tape reading skills are now starting to work as the price enters a 60-minute bullish consolidation that lasts for 8 hours (black rectangle on the 60-minute chart).
The lack of selling pressure makes us more confident to play a higher exit, which has three advantages. First, it will reach 80, which is the natural open interest target during the expiration period. Second, it will launch the top Bollinger Bands, triggering common sell signals. Third, after a small-scale breakthrough encourages new people to take risks, it will reach resistance. We use their greed to enter magical numbers, and make substantial profits when predators line up to prey on newly minted bulls.
Trading advantage defines your technical or strategic advantage in a highly competitive market environment. Traders can build multiple advantages by starting with popular strategies and customizing rules to reduce the risk of falling into an emotional crowd.