One of the most common quests for trading excellence early in a trader’s career is the search for an all purpose, robust trading secret which can be used to guide the trader through all markets, in all time frames, in any conditions, regardless of the instrument being traded, the size of the position, and your goals and objectives.
In some ways this is a legacy of the increasingly academic pursuit of truth in the marketplace fueled by the need for institutional money and those charged with a fiduciary responsibility for the money of others to employ only the most rigorously tested and objectively powerful strategies. The combination of sizeable management fees and the seriousness of the legal implications of being a fiduciary certainly are compelling reasons alone, but part of me believes that there is also a commitment to the scientific pursuit of objective truth that is there as well.
Almost every sound piece of academic research establishes that there are no enduring edges that an individual trader can take advantage of, and we are advised to follow efficient market theories in various forms to ensure we get the average market returns.
And yet there traders who consistently make better than average returns. Many are simply lucky and have confused a “to-be-expected” run of luck with skill, and find themselves running out of luck when they are at their maximum exposure level, and are never to heard from again except as an admonition to avoid timing the markets or aiming for more than average.
It is a paradox of course, since only by having individual actors striving for abnormal returns will the market mathematically achieve the efficiency required by academic theory.
When you peel back the onion a little and examine the traders who seem to have an edge not completely explainable by luck and the law of large numbers, there are many who have focused on their ability to link an assessment of market conditions for their selected targets to an appropriate strategy designed to exploit their particular edge.
Crucial to this strategy is the development of a market classification scheme that is related to the underlying dynamics of the chosen market, and which is in tune with the average length of holding positions so that favorable moments that are actionable can be identified.
Individual traders who have found a sweet spot for their edge can apply this idea to improve their average returns, and identify moments of higher than average expected returns. In other articles I will describe some ways that offer insights into this strategy.