Author of Trading in the Zone Mark Douglas defines trading edge as “nothing more than an indication of a higher probability of one thing happening over another.”
This market edge has to be objective and quantifiable, which means it’s backed by numbers and statistics.
You’re probably rolling your eyes and groaning “Ughh, math and spreadsheets!”
It ain’t an edge if you don’t know the probability of the outcomes!
You wouldn’t bet big in poker if you have absolutely no clue about the chances of your hand winning, would you?
To have a reliable idea of the probability of your trading strategy’s success under various market conditions, you would need to do some back testing over a looong period of time.
And if the numbers aren’t really showing any consistency or strong odds of winning, you would likely need to make some adjustments with the indicator settings or entry and exit rules.
From there, you gotta run more sets of tests to see if there are any improvements.
Market Wizard Mark Minervini in his book Think and Trade Like a Champion writes:
By defining my parameters ahead of time, I establish a basis for knowing whether my plan is working or not. Have a process, any process, but have a process. Then you have the basis from which to work, make adjustments, and perfect your process.
I know, I know… This means a lot of grunt work and would probably get boring. But if you put in the time and effort, it could really pay off.
Aside from creating your own system rules and running tests, you can also opt to learn from a mentor or trading coach.
This isn’t a shortcut, though, since you must do your research on whether or not their framework or strategy has been proven to work.Besides, your goal should be to eventually trade independently instead of relying on other people’s trade signals.
Journaling your market observations, let’s say a reaction to a particular news release or price patterns that play out, is also a good practice when it comes to fine-tuning your trading edge.
Knowing whether or not a setup has a high probability of winning could eliminate a great deal of trading stress, even if you’re still facing market uncertainty.
Having a track record that shows consistency in the long run gives you the confidence to take trades that line up with your system rules. More importantly, it also gives you some reassurance that the strategy can bounce back after a loss.
In turn, trusting your market edge prevents you from trading impulsively or taking revenge trades. It helps you stay disciplined in sticking to your strategy rules instead of giving in to fear and greed.