Transcription
Most traders think they have an edge, but they don't. They are gambling. Here are the six types of trading edges and how you can find them.
Hi, I'm Lance Brightstein. I've made over $und00 million in verified profits and I'm a mentor to seven and 8 figure P&L per year traders.
Do you ever wonder where the phrase "the house always wins" comes from? Or think about why the house always wins? It's because at casinos, over the long run, the odds are stacked in their favor. Casinos have positive expectancy over the long run, and as a trader, having an edge is crucial to consistent profitability.
Edge also has a related meaning when used in phrases like "having an edge." In that case, an edge is a factor or advantage that increases the long-run expectancy of your bets to above zero. There are several types of edge that a trader can exploit, and they exist due to various market dynamics and inefficiencies.
Information edge. Traders can gain an information edge by having access to news, data, or analysis that is not widely available or understood by the broader market. This could include access to proprietary research, the ability to process large amounts of data more efficiently, or even insider information, which is often illegal, but an edge nonetheless. Information edges exist due to the uneven distribution of knowledge and the inherent complexity of financial markets.
Keep in mind that while there are multiple types of edge, they are not exclusive of each other. The best traders typically apply more than one to give them the best advantage of being successful in any given moment.
Circling back to having access to news, it is uncommon for the average retail trader to have access to a Bloomberg terminal. Having Bloomberg already gives a trader more edge than 99% of traders out there. But now you're competing in a world primarily against institutions. So, how do you beat them if you have all the same information? This bridges us to the next type of edge, technological edge.
In today's high-speed trading environment, having superior technology can provide a significant edge. This includes low latency trading platforms, colllocated servers, and sophisticated algorithmic trading systems, even keyboard hotkeys. Technological edge exists because of the arms race amongst traders to execute trades faster and more efficiently than others. Technological edge increases speed, and in this world, every microsecond counts.
"It's going to be very fast and it's going to make us all very successful."
Don't be discouraged if you don't have access to trading technology that professional firms use. There are many different ways. I used to tinker with improving speed that had nothing to do with the trading technology I was using. Receiving tweet notifications faster. Trying to find a more direct live stream source for CNBC or even finding the source where specific court cases are posted. Programming, custom web scrapers, and more are all examples of how traders can develop technological edges. You just have to think outside the box of what you're limited to.
Analytical edge. Some traders have an analytical edge due to their ability to identify patterns, trends, news stories, or market inefficiencies in ways that others might miss. This could involve developing proprietary trading strategies, advanced statistical analysis, or a deep understanding of market dynamics. It's possible everyone has the same news, but you might be able to analyze it in a way that is more accurate than other people are able to assess. For example, biotech analysts have an edge interpreting drug data that many market participants might otherwise not have. I know traders that are experts in biotech. They've put in the time to know about the FDA clinical trials. They know when the data is being released and what the analysts are looking for. Another way of viewing this type of edge is even from a technical analysis perspective. Everyone has access to the same price data generally, but certain traders are able to analyze the charts in a way that beats the market over time. They found edge in their chart analysis. Analytical edges exist because markets are complex, and not all participants have the same level of skill or insight in interpreting data.
Psychological edge. Successful traders often possess a psychological edge in terms of discipline, emotional control, and risk management. They can execute trades without being influenced by fear, greed, or cognitive biases that may affect other traders. Psychological edge exists because trading is inherently stressful, and human emotions can easily derail even the most well-designed strategies.
Think about two traders who both take a large loss to start the day. Trader one is highly discouraged and has almost given up on the day, while trader two knows it's part of the job and looks for the next best trade. The afternoon rolls around, and there is a huge opportunity. Trader one is still shaken up from the morning and doesn't size aggressively or maybe doesn't trade it at all out of fear of losing more. Trader two recognizes this trade is a great opportunity regardless of what happened in the morning and sizes up and executes masterfully to put him back to being positive on the day. That psychological edge is what kept trader two in the game.
Many might infer that algorithmic trading is therefore better, but it isn't that straightforward. Sometimes our emotions and intuition can be advantageous to us in ways that can't so easily be programmed into an algorithm. For experienced traders, that feeling can be a huge advantage.
Liquidity edge. Traders may have a liquidity edge if they can access deeper pools of liquidity or execute large orders with minimal market impact versus other participants. For example, this can be achieved through direct access to dark pools or relationships with brokers. Liquidity edges exist due to the fragmentation of markets and the varying levels of trading activity across different instruments or venues. Additionally, most retail traders have the advantage of being far more nimble than larger players. This allows them to make money that is meaningful to them but might not move the needle for other players.
Structural edge. In some cases, traders may exploit structural edges that arise from market inefficiencies, short availability, regulatory loopholes, or arbitrage opportunities. For example, discrepancies in pricing across different exchanges or asset classes can create temporary mispricings that skilled traders can capitalize on.
This list isn't exhaustive, and there are all types of small advantages. Some traders and firms might have enormous staying power due to their capital base when others aren't necessarily well capitalized. This was huge during the great financial crisis and even during COVID. There were exchange-traded funds that were trading at huge discounts to net asset value during some of the disconnects. Other traders have expert networks and access to IPO allocations. Structural edges exist because financial markets are not perfectly efficient, and there are often opportunities for those who can identify and exploit these inefficiencies.
The reality is that most traders don't have just one type of edge, and the above list isn't even exhaustive. Most traders utilize a combination of the above to make a living and are always looking to strengthen and combine as many types of edge as possible. That's what gives career traders such a huge competitive advantage.
It's important to note that edges can be temporary and may erode over time as other market participants become aware of and adapt to them. The best traders always adapt to new edges as soon as possible. If an edge is proven once, they are prepared for it to happen again. That's what creates separation between the greats and the average Joe's. You must constantly seek new edges or refine existing ones to maintain your competitive advantage and profitability in the ever-evolving financial markets. It's something I've done my entire career, and I can't stress enough how important of a role this plays in being successful long term.