Taming risk and mastering your edge

Everything in trading comes down to edge …

Yet many traders couldn’t even tell you the kind of edge they’re trading with. Here’s everything you need to know …

What’s an edge?

Your trading edge is the statistical advantage you have over the markets. It doesn’t tell you how much you’ll make in the next trade, or in the next ten trades … it takes many repetitions for an ‘edge’ to play out.

If your edge over the market remains consistent, you’ll make money.

A good way to explain how an edge works is to look at an institution that’s a real pro at maintaining their edge: the casino.

Las Vegas casinos make their money by maintaining an edge of around 5%. So, out of every dollar that is brought into the casino, 5 cents stay there, and 95 cents go back to the players.

But that doesn’t mean that your average player at the roulette wheel leaves the casino with 95% of what they came in with. That house edge applies to the amount you bet, not what you walk through the door with. So, let’s say you sit down at the roulette table with $100 and bet $10 a spin. When you win, you add that back into your bank, and keep going. Let’s say that the wheel spins 50 times in an hour – you’ve gambled with $500.

The casinos aren’t gambling – they are playing the odds. They have an edge, and they just keep repeating.

They don’t care if someone hits the jackpot on a slot-machine. As long as people are coming in through the door and putting their money on the table or into the slots – they’ll keep taking their 5%.

So, how do you apply this to your own trading?

Finding your edge

Your trading edge comes from a combination of winning often enough and winning big enough.

If your trades are risking 1:1 (i.e. your risk is the same as your reward), you’re going to need to win more than 50% of the time to make money.

So, if 45% of the time you’re losing £100, but 55% of the time you’re winning £100 … you’re going to come out on top.

Your ‘edge’ is calculated as your win rate minus your breakeven level.

So, if your breakeven rate is 50%, and you’re winning 55% of the time, then your edge is 5%.

To calculate this, you’ll need to know your average win size, your average loss size and your win rate.

An easy way to keep tabs on all these stats is to use the Trader’s Bulletin Trading Journal, which calculates it all for you.

Consistency

Just like the casino winning 5 cents in every dollar … a trading edge may seem pretty modest. But its value comes from being able to repeat it .. again and again.

And that’s why your trading strategy needs to be applied with consistency. It’s only by repeating the ‘trick’ you’ve got over the market that you’ll see the trading edge play out.

This means that your system must be repeatable – it must have clear rules that you’re going to be able to replicate.

Managing volatility

Your edge will not play out evenly. There’ll be winning runs and losing runs.

That’s why it’s important to be able to repeat your strategy with consistency, which will allow your ‘edge’ to show itself over the longer term.

This ‘bumpiness’ along the journey is what causes so many traders to lose faith (or to simply lose their bank!). To keep going, it’s important that you:

• Don’t overstretch yourself: if you risk too much per trade, you’ll get knocked out by a losing run, putting a halt to your ability to keep repeating.

• Smooth the ride: don’t build your bank size too quickly.Have faith in your methods: this comes down to trusting the track record you’ve built that proves your edge over past data. (Past data can’t predict the future, but it’s about the best metric we have!)

Keep measuring

Being consistent doesn’t mean plodding on mindlessly – keep a close eye on your results to check that your win rate and win/loss sizes aren’t going off the rails. Market conditions change, and we need to be able to adapt.

Again, make sure you’re using a trading journal.

The reality of trading edges

Finding your edge in the markets is the golden ticket in trading, but maintaining that edge means that you need to keep learning and adapting, monitoring your position sizing, and building on your experience.

Don’t expect your edge to be a static thing – it’ll wax and wane, but, as your trading skills improve, you should see it steadily build over the years, becoming more consistent.

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