Putting Losses in Perspective - Structuring a Trading Plan to include the Edge

In the previous post we talked about what an edge is and how do we know if we have one?

If you are beyond that, it means you have crossed a big milestone, as most (90%) of people that I know, can't get past that.

But knowing about an edge is hardly sufficient to make it work. You also need to know how and when to execute trades in the context of that edge. We will not get much into all aspects of execution today, but focus more on the “Rules” for execution i.e the Trading Plan

Think of the following questions before you create a trade plan

1. What are the prerequisites for you to enter the trade - Meaning what are the the confirmatory elements that you need. It could be defined in terms of factors like - Price Range, Time of the Day, volume levels etc. any measurable variable

2. Would you wait for a confirmation on all variables or there is a prioritization among them, or weightage.

3. Would you enter all at once or would you scale in / pyramid into the position?

   1. How much would go in the first tranche and the subsequent?

So you put the trade - and next

1. What would you do if

   1. You don't get a fill

   2. You get a partial fill

2. Where would you Stop Loss be?

   1. Is it going to be dynamic or static?

3. Are you going to Exit in full size or you would scale out in parts?

   1. How would you determine the scale out ratio?

   2. What if the price reaches 90% to your target and does not move beyond? Would you wait for up your Stop loss or Cover?

   3. What would be the buffer/variance where you will cover your trade even if it does not hit the target precisely.

      1. On what basis would you cover or hold?

Having answers for all these questions, answers informed by data i.e. - ought to be your next milestone

Putting Losses in Perspective - Do you have an Edge?

One of the fundamental reasons for losses in trading can be traced to lack of an “Edge”. But then you would ask me what is an Edge?

To me a trading edge is -

An ability to isolate a condition or a set of conditions among a market variable or a set of market variables - that has a non random way to evolve over a specific period of time.

I remember reading somewhere, but I cannot place it where - it said - “If you can’t explain your trading edge, you don’t have one” - Let me take it to the next level

If you do not know the statistical a) probability of the set of (prerequisite) condition/s that need to occur b) the probability distribution of the outcomes once the conditions (a) occur.

If you cannot articulate both then in my world you do not have an edge.

It’s quite possible that you are a veteran and even though you cannot articulate your edge, you have internalized it over a long period of time. But that according to me is a long winded route and I would personally prefer to be in the know of my edge.

So coming back to losses, the reason we need to be able to articulate our edge is - in the event of a loss, we need to know if its a part of our larger probabilistic framework or is it something which is beyond that. We need some objective reference. For example if you have a loss streak of 5 days, you need to know its statistically “normal” in your trading system or is it an anomaly.

In other words, your understanding of the variables of your edge helps you put your trading outcomes in a measurable context.

In the same breadth, it also helps us understand if the market regime itself is changing, and helps us adapt better.

So the next time you make a loss you know who to catch first?