Beware the dangers of high-performance trading methods. Because, again and again, it’s the ‘good enough’ trading results that trash the ‘best’ ones over the medium to long term.
There’s significant evidence in all walks of life that we should be wary of the ‘best’. The greatest accomplishments come not from pushing ourselves to the limit, but from gradual, consistent repetition and improvement.
After a decade of repeated injuries in my knees, I’ve recently got into the 80:20 program for my sports training. Instead of pushing myself too hard, for 80% of my time, I work at ‘easy’ effort. I keep my heart rate low and enjoy the scenery when I’m out for a run, instead of trying to put in a heroic personal best every week.
The result is that I’ve managed to train more consistently than I ever have in my life.
No injuries (okay, the odd niggle – I am pushing 50), but there have been no weeks off to rest with an icepack on my knee.
So how does this relate to a trading?
Understanding your edge
There’s a lot of misunderstanding about what a trading edge is.
Some ‘gurus’ would have you believe that it’s some secret piece of info they have about the markets. But your ‘edge’ just comes down to finding a method that is consistently making more money that it’s losing.
All trading methods lose some of the time. Some even lose a lot of the time. Whether they’re profitable or not comes down to a simple equation between how often they win, and how much they win vs how much they lose.
A trading method with an edge will have what’s called a positive expectancy – i.e. it wins more money that it loses.
So, the bigger your edge … the more money you make … and the better your trading method … right?
There are two danger points to watch for if your edge is too big …
1 • Volatility
If your profits have had a meteoric rise, there’s every chance that they’ll be susceptible to the same kind of drawdown.
If you think about a profit curve, a trading method with a modest edge might look like the green line below. While one with a significant edge could show ups and downs like the blue line …
The journey of the blue line might look promising, but if you’d got on board that method a bit late, you’d be out of pocket compared with the steady performance of the green line.
2 • Market efficiency
There’s an economic theory of ‘efficient markets’ – it tells us that information flows freely, and investors make rational decisions based on that information.
The reality is that markets aren’t perfectly efficient, and investors are often anything BUT rational.
However, what does happen, is that ‘edges’ will eventually be naturally ironed out by markets.
If you discover a loophole which is making you a load of money … that loophole will naturally close up.
If someone’s selling something too cheap, demand will rise and the market will self-correct.
Sometimes it happens almost instantly.
Sometimes it can take a long while.
A very experienced investor I used to work with found a mis-priced instrument and raked in a fortune over 18 months before the market ‘corrected’. But these kinds of gems don’t come along often!
Generally speaking, the bigger the loophole … the more powerfully market efficiency will come into play.
Finding your 80% level
Just as long-term fitness builds better with lower-effort workouts … and machines last longer if we’re not using them full-throttle …
Our trading performance will improve if we’re not constantly pushing for more edge, more optimization, more leverage, more trades.
It’s in this magical ‘goldilocks’ zone that we find consistency – the real holy grail to trading success.
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