Position Sizing or Diversification?

[BlueHorseshoe 10]

Suppose you have a limited amount of capital and trade one contract in one market. You're a good trader, and after a certain amount of time you have doubled the account. What's the best thing to do next . . .

 

1. Increase your position size and trade two contracts?
    
   
2. Diversify by trading a single contract in a second market and continuing to trade a single contract in the orignal market?
   

In other words, if you don't have the luxury of a portfolio sized account to begin with, how do you subsequently reconcile the allocation of capital to secondary markets with position sizing in the first?

 

BlueHorseshoe

[MightyMouse 12]

I would add contracts to the markets I trade and then only add contracts to the markets I trade well. So, if I did well trading ES, but not CL or 6E, then I would only add to ES.

 

I think of it as a cash poker game. If a new guy sits down to play and is not familiar with how any of the other players play, he will lose big most of the time unless he has an incredible string of lucky hands or sucks out a lot. It really doesn't matter how good he is at determining the odds if he doesn't know that Bobby won't call a raise or that Timmy won't fold no matter what or that if Mike calls preflop he likely has a minimum of A10s if he is in mid position, etc, etc. Even though the game is the same, the players are different at each table.

[Obsidian 10]

Suppose you have a limited amount of capital and trade one contract in one market. You're a good trader, and after a certain amount of time you have doubled the account. What's the best thing to do next . . .

 

1. Increase your position size and trade two contracts?
    
   
2. Diversify by trading a single contract in a second market and continuing to trade a single contract in the orignal market?
   

In other words, if you don't have the luxury of a portfolio sized account to begin with, how do you subsequently reconcile the allocation of capital to secondary markets with position sizing in the first?

 

BlueHorseshoe

 

I would continue to trade what I am good at

[BlueHorseshoe 10]

I would continue to trade what I am good at

 

Assuming you were equally good (ie had a workable strategy) for a dozen instruments though . . . Do you try and spread risk across multiple strategies and markets through diversification, or do you try and compound your way to vast riches but remain totally at the mercy of one market and strategy?

 

BlueHorseshoe

[addchild 10]

Suppose you have a limited amount of capital and trade one contract in one market. You're a good trader, and after a certain amount of time you have doubled the account. What's the best thing to do next . . .

 

1. Increase your position size and trade two contracts?
    
   
2. Diversify by trading a single contract in a second market and continuing to trade a single contract in the orignal market?
   

In other words, if you don't have the luxury of a portfolio sized account to begin with, how do you subsequently reconcile the allocation of capital to secondary markets with position sizing in the first?

 

BlueHorseshoe

 

I would consider a few things,

 

1. Dance with the girl that brought you to the party.

 

2. If you decide to trade more markets, are the markets correlated? in other words, is the risk correlated?

 

If the markets are correlated I would forget it. With correlated risks, you will likely end up with similar outcomes while sacrificing attention.

 

Also you should consider volatility and contract value.

[4EverMaAT 10]

If you can only pick one, why not continue with what you are already good at?

[wrbtrader 10]

Suppose you have a limited amount of capital and trade one contract in one market. You're a good trader, and after a certain amount of time you have doubled the account. What's the best thing to do next . . .

 

1. Increase your position size and trade two contracts?
    
   
2. Diversify by trading a single contract in a second market and continuing to trade a single contract in the orignal market?
   

In other words, if you don't have the luxury of a portfolio sized account to begin with, how do you subsequently reconcile the allocation of capital to secondary markets with position sizing in the first?

 

BlueHorseshoe

 

Hi,

 

Assuming we aren't talking about a trader using an automated trading system...

 

Continue trading one contract considering the trader is a good trader and has the ability to double the account size while only trading one contract. If it ain't broke, don't fix it.

 

Yet, if the trader decides to increase position size, do such only after about 1 - 2 years of consistent profitability via the prior position size. The 1 -2 years time span will allow the trader to have real trading experience in a few different types of market conditions to help prepare/determine if increasing position size is appropriate.

Edited October 23, 2012 by wrbtrader

[Obsidian 10]

Assuming you were equally good (ie had a workable strategy) for a dozen instruments though . . . Do you try and spread risk across multiple strategies and markets through diversification, or do you try and compound your way to vast riches but remain totally at the mercy of one market and strategy?

 

BlueHorseshoe

 

we should be careful while spreading risk. sometimes we reduce the risks through diversification, but sometimes we make it double...

everybody has their limits (focus, research, analyze etc) and market conditions change

[MightyMouse 12]

Hi,

 

 

Yet, if the trader decides to increase position size, do such only after about 1 - 2 years of consistent profitability via the prior position size. The 1 -2 years time span will allow the trader to have real trading experience in a few different types of market conditions to help prepare/determine if increasing position size is appropriate.

 

 

I look at it is a function of account size. If the account doesn't grow, I have no business adding contracts.

[dragon987 10]

I would continue focus only on my one market which I trade well (otherwise I would not have doubled the account). Then I would analyse continously my trades, especially, win/loss ratio and largest looser etc etc. and would run a monte carlo analysis (supposing you have a larger number of trades). With that you can find out, which draw down you can expect when applying a certain method and a given account size. Then, if that is all OK and gives green light to upscaling, I would trade a second contract, and apply one of the methods for position sizing ie. fixed ratio or so, and strictly following that, meaning, when the account is falling back below the threshold, I would reduce the contract number back to one - and continue as usual. This inevitably leads you to increasing contract sizes, since you are continously profitable and controlling your risk adequately. Given that your method gives you a reasonable frequency of trades and the market has enough liquidity, no need to consider an additional market to trade at the same time.

Only my humble opinion.

Cheers.

[BlueHorseshoe 10]

If you can only pick one, why not continue with what you are already good at?

 

Because past results are not indicative of future performance? Whereas effective diversification could be indicative of reduced risk?

 

BlueHorseshoe

[BlueHorseshoe 10]

no need to consider an additional market to trade at the same time.

 

What if your chosen market suddenly starts to behave differently? You won't "blow up", but you might lose profitability. It's quite likely that this change of behaviour will happen; the probability that all markets in a non-correlated portfolio would start to behave differently all at the same time should be much lower. Or not?

 

BlueHorseshoe

[BlueHorseshoe 10]

I would consider a few things,

 

1. Dance with the girl that brought you to the party.

 

2. If you decide to trade more markets, are the markets correlated? in other words, is the risk correlated?

 

If the markets are correlated I would forget it. With correlated risks, you will likely end up with similar outcomes while sacrificing attention.

 

Also you should consider volatility and contract value.

 

A totally valid point but . . . at the critical, high volatlity times, does intermarket correlation increase? Are volatility and correlation . . . positively correlated? Look at the last crash - pretty much everything did the same thing at the same time - instruments that now trade again as though they don't know one another exit.

 

Is strategy diversification rather than market diversification the answer?

 

BlueHorseshoe

[DavidChazin 10]

Trading a second, relatively non-correlated market will smooth out your equity curve. In other words, your drawdowns (losing streaks) will become a smaller percentage of your net profit, thereby lowering risk.

[4EverMaAT 10]

Because past results are not indicative of future performance? Whereas effective diversification could be indicative of reduced risk?

 

BlueHorseshoe

 

Diversification still leaves you at the same decision point: Past results are not indicative of future performance. But instead of worrying about 1 instrument, you now have 2 instruments in which to contemplate that question.

 

The suggestion on strategy diversification is perhaps more valid, although again: past performance is not indicative of future results. But by diversifying strategy, you may have a higher survival rate as if one strategy does not blow up, another one will. But if you are trading similar core strategies, but with different risk levels (position sizes), then statistically you can measure which strategy can survive certain market conditions better.

 

So are you using the same core strategy, but different position sizing/parameters on different instruments? Or the same strategy on two different instruments? Or the same core strategy, but different position sizing (and other parameter changes) on the SAME symbol?

 

It's a matter of preference. I say stick with what you are familiar with (either the core strategy on a different market, or the same market, but increase the position size). You are familiar with your strategy and the first market you are doing well with. No need to reinvent the wheel.

[ForexTraderX 10]

Because past results are not indicative of future performance? Whereas effective diversification could be indicative of reduced risk?

 

BlueHorseshoe

 

Blue, I'm gonna pick on you here a bit, but don't take it personally. Frankly, you ask good questions, and often have a well developed understanding of how markets work as well as an awareness of risk, etc....

 

But I think your missing the forest for the trees a bit here... here's how.

 

Your essentially quoting investment industry cliche's, but your taking them out of the context in which they were intended for, as well as not considering WHY these cliche's exist in the first place. I'll take them one at a time...

 

"because past results are not indicative of future performance" Ok. Fine. This is technically true... but if we carry it to the nth degree.... your boss might as well fire you from your job now, because, well, no matter how good you are at your job, past performance is not indicative of future results ya know. And if your wife wants to have a 2nd child? well, call up the adoption agency. Because just because you had it where it counts the first time around, doesn't mean that you can still "deliver". Sterility is a real fact of nature for some anmials, and after all, past performance is not indicative of future results.... etc...etc..

 

I think you see my point (gosh I HOPE you do... or I'm just gonna come off sounding like an inappropriate, insensitive, pervert of sorts!)

 

Ok...so, what exactly is this statement all about then? Well, after the great crash of 29, many rules were implimented over future decades that existed for the purpose of preventing greedy, slimy pitchmen from showing a trading record, and then making promises that "I'm this good at trading. And if you invest with me, I guarantee I'll make twice as much for you as I did with my trading last year!"

 

In other words, it is a legally required disclaimer designed to protect the investing party by letting them know that in truth, this is an investment opportunity that they have no real control over, and therefore must understand that it may not be as good as they would like to believe it is.

 

Now, what investments do they NOT require this disclaimer to be attached to? How about raising capital for a public offering.... or, starting your 3rd pizzaria, or investing in your 7th real estate deal.

 

But...how come? The key issue here centers around "Control". When you give your money to someone else, you give away your control. Therefore, the disclaimer acts as a way to keep your expectations realistic, as well as protect you from giving up control to a would be confidence man who promises the moon but gives back something less....

 

HOWEVER, if YOU are your own investor, your own trader, your own entrepreneur.... you have an infinitely greater degree of control in this situation. So while there ARE still black swan events, outliers, etc.... you can have a specific plan (like stop loss orders, drawdown limits, and many other things) that will account and protect you from each individual "threat" that you may encounter as you run your trading business.

 

And if your strategy is based in something that is pretty much intrinsic to the nature of the liquid, auction market model that 99.9% of the capital markets in the world operate under... then you can be pretty sure you will be able to continue to perform at a respectable, profitable level for probably decades into the future (unless human nature itself changes...but then all bets are off)

 

The point here is that the cliche "past performance is not indicative of future results" is actually NOT an accurate description of a universal truth! It is a LEGAL DISCLAIMER to prevent hucksters from overpromising and under delivering to the relatively unsophisticated investor. It has very little, if any, application with regard to a persons own ability to trade profitably...or for that matter, invest in real estate profitably, or operate a McDonalds fanchise profitably, or even wake up in the morning successfully!

 

And this brings me to the 2nd cliche that you use...

 

"effective diversification could be indicative of reduced risk?"

 

"could be" being the operative phrase in that sentence. It COULD BE evidence of total retardation, and I suppose it COULD BE submitted as proof that aliens walk among us...

 

lets forget could be for a moment...and go back to the very beginning of the concept of "diversification is a way to reduce risk"

 

The REAL story is that cliche was born with a twin sister... something we now like to call a "mutual fund" Because the industry had to cook up some way to justify criminally high fees and charges to your retirement account all for underperforming what you could have usually made just investing in the broader U.S. equity markets...

 

And the way they sold that sack of shit was by saying "ahh... you see, if you take your retirement money, and buy a stock with it. That company could go bankrupt. ANd if they do, you've lost your entire investment!! But, if you invest with our (name brand here) mutual fund, we will spread your money across such a cacaphony of generalized corporate holdings that if one company goes under, it's represents less than 1% of your entire retirement, so a bankruptcy or problem for a publicly traded company won't hurt you hardly at all (you're also doomed to underperform the market from here till retirement, all the while paying us miillions of dollars every year to suck at our jobs...but hey! look at the bright side... if IBM has a slow quarter, you'll only lose a few hundered dollars, instead of a few hundered thousand!!)

 

So, all cynicism aside... what EXACTLY is the risk that "diversification" has reduced??? It really only reduces the risk for a passive investor who does not pay much attention to, nor does he understand, what he is invested in.

 

But, does this describe a type of risk that applies at all to the active and engaged day trader??? No! not even a little bit! We are so tuned in, over stimulated, focused beyond belief, and constantly looking for "what caused this move?!?? what caused that move?!?!?!!!!" that there is really NO WAY that we run the risk of putting our money into a stock, or futures contract, or whatever, and then watching our money get flusehd down the drain because we were too lazy or ignorant to follow the industry, or the company, and see the 137 signs that it was in trouble (like that obvious and gorgeous downtrend the stock has been locked into for the past 9 weeks...etc)

 

You diversify to protect against the risk of lazyness. Of financial apathy. It gives you the luxury of being able to NOT look at the market for 12 months at a time, and usually not worry to much that the bulk of your money will be there next year.

 

If your trading a futures contract.... lol. I'm laughing just thinking about it. Go ahead. Try to go long or short any contract...and then turn off the charts, and tell yourself not to worry, you'll come back in a year, and see how things are going! LOL!

 

As warren buffett so elequently put it "Diversification is just a hedge against stupidity"

 

You need to consider exactly HOW these cliches operate... because if I tell the guy who runs the gas station at the corner that his business model is fucked, because he has no diversification, in that all he sells is gasoline.... well, he may be a one product guy, but something tells me he doesn't have a whole lot of risk in his business, dispite being a 1 product guy.

 

Remember, the entire existance of the antitrust case law that we have in the U.S. was because the U.S. federal government thought that some companies were too powerful for the good of competition... but funny thing is... standard oil... microsoft, ticket master... these companies aren't known for their broad "diversification"!!!

 

"Diversitication" does NOT equal "Less Risk"

 

"Diversification" DOES equal "reduction of a very specific, somewhat rare and exotic type of risk"

 

but as a day trader, your exposure to said rare, exotic risk is almost nonexistent.

 

Don't accept cliche's at face value. Try to find circumstances and situations that they DON"T work.... because that will provide you insight as to how they apply, and this insight will help you be better prepared to know the right course of action for your own financial decisions.

 

Hope this helps a bit. It's rather long, I do apologize.

 

FTX

[BlueHorseshoe 10]

Don't accept cliche's at face value. Try to find circumstances and situations that they DON"T work.... because that will provide you insight as to how they apply, and this insight will help you be better prepared to know the right course of action for your own financial decisions.

 

Hope this helps a bit. It's rather long, I do apologize.

 

FTX

 

Hi FTX,

 

Thanks for an excellent response!

 

By trotting out those cliches I wasn't meaning to imply that I agree with them, but rather wanting to open them up for discussion - that's why I placed question marks at the end of each sentence to try and make them less declaritive. From what I've experienced in the past at TL, it can be quite tricky getting people to engage with money management type threads!

 

As far as the cliche is old, I guess it's pretty much the problem of induction (David Hume? 1600 and something?) - "just because past futures resembled past pasts doesn't mean that future futures will".

 

What about if we remove the grayer shades of mutual funds and Warren Buffet's returns? Suppose you had to keep your entire net worth in inflation-indexed fixed income government bonds (with no currency risk). So unless the issuing government goes bust, there is hypothetically no risk. Would you purchase the bonds of just one nation? Would you not try and diversify, imagining a scenario thirty years down the line where, say, the UK became economically unstable?

 

That takes things off at a bit of a tangent, but then I started the thread, so . . .

 

BlueHorseshoe

[ForexTraderX 10]

Hi FTX,

 

Thanks for an excellent response!

 

By trotting out those cliches I wasn't meaning to imply that I agree with them, but rather wanting to open them up for discussion - that's why I placed question marks at the end of each sentence to try and make them less declaritive. From what I've experienced in the past at TL, it can be quite tricky getting people to engage with money management type threads!

 

As far as the cliche is old, I guess it's pretty much the problem of induction (David Hume? 1600 and something?) - "just because past futures resembled past pasts doesn't mean that future futures will".

 

What about if we remove the grayer shades of mutual funds and Warren Buffet's returns? Suppose you had to keep your entire net worth in inflation-indexed fixed income government bonds (with no currency risk). So unless the issuing government goes bust, there is hypothetically no risk. Would you purchase the bonds of just one nation? Would you not try and diversify, imagining a scenario thirty years down the line where, say, the UK became economically unstable?

 

That takes things off at a bit of a tangent, but then I started the thread, so . . .

 

BlueHorseshoe

 

Glad you liked the post... and I have my thoughts on your comment here, but as you say yourself...we arn't exactly talking about day trading any more.... but I don't think I can give you a real answer in this new hypothetical... because like most things in life, diversification comes with a cost. I mean, all things being equal, if you could keep your entire net worth in such a instrument, I would need to know what I give up to diversify... control? flexibiilty? interest rate? good credit rating? relative stability of one nation to the other.... etc...

 

I suppose two such instruments issued by two different nations that were essentially "twins" of each other, meaning same basic GDP, credit rating, interest rate, fees, taxes, etc.... Then I probably would diversify between them both, as a hedge against largescale fradulent activity that could poentially render a crippling financial blow if when it is uncovered...

 

but, it's never this straight across. In real life where most of us live... I would make sure the government issuing the bonds was stable enough (or the returns high enough) to justify the investment in the first place. If a nation met this criteria, I would choose the best of those that met it. It would be more of a "pass or fail" situation...and I'd likely choose from the ones who "passed", but also offered the best terms for my particular needs and situation.

 

It really comes down to this. Knowing what you want, and knowing what you NEED... and knowing the difference between the two. Once you know this, an investment of any kind either fits the criteria, or it doesn't. If it fits all your needs, AND your wants... it doesn't mean that it's the perfect investment for you.... but it does mean that you can ignore all the outside noise, cliche's, "common knowledge" and other gibberish... because none of that matters to you anyway. All that matters is that your needs are all addressed, and hopefully you get a lot of your "wants" met as well. If this is the case with an investment, then really nothing else matters.

 

FTX

[MightyMouse 12]

What if your chosen market suddenly starts to behave differently? You won't "blow up", but you might lose profitability. It's quite likely that this change of behaviour will happen; the probability that all markets in a non-correlated portfolio would start to behave differently all at the same time should be much lower. Or not?

 

BlueHorseshoe

 

It is a given that your market will behave differently over time.

 

You can't keep taking money from the same people without them going broke or learning.

[ForexTraderX 10]

It is a given that your market will behave differently over time.

 

You can't keep taking money from the same people without them going broke or learning.

 

I'm not so sure about the "market will behave differently over time" assertation. I mean, in a broad sense, ya, sure, absolutely. But I don't think it has much to do with individuals going broke or learning.

 

Yes, I do think individuals go broke. And I do also think that they learn. But human nature doesn't change...and every day, some market participants die off, and new ones enter the markets. The "changes" that we observe in markets are largely a function of basic market structural changes (decimilization of the stock market for example), technology changes (HFT and home based retail trading), or business/economic cycles and trends (dot com era, long term american financial growth/decline...etc)

 

I think those 3 types of factors actually can and do change the behavior of markets for large periods of time, and possibly even permanently (like the internet has done).... but the effect of individuals changing the markets as you infer would require a proportionally higher amount of people to either "figure it out" or "go broke" than existed at some previous point in history. And I doubt that this is ever really the case.

 

Access to helpful resources and information has become better, but so has access to a larger amount of misinformation and bad advice. The barriers to entry as a trader have become significantly lower over the past 20 years, but that brings as many more bad traders than good traders.

 

I could go on and on...but I think in the end, what distinguishes some from the rest is that they are flexiable, confident, determined, capable, talented, and deeply desire to be successful traders. And the rest are missing one or more of these characteristics.

 

And I don't think time is a function of it here. As ed Seykota once said something to the effect of: "many are called and few are choosen"

 

Markets can and do behave differently over time. They also always behave the same...just the scale and proportion and ratios of each phase of a market cycle will change.

 

But they don't change because some go broke and others learn. As a species, we reproduce too fast, change too slowly, and die off too often for individual change to somehow add up in the aggregate in a way that alters the way a market rises and falls.

 

FTX

[MightyMouse 12]

I'm not so sure about the "market will behave differently over time" assertation. I mean, in a broad sense, ya, sure, absolutely. But I don't think it has much to do with individuals going broke or learning.

 

Yes, I do think individuals go broke. And I do also think that they learn. But human nature doesn't change...and every day, some market participants die off, and new ones enter the markets. The "changes" that we observe in markets are largely a function of basic market structural changes (decimilization of the stock market for example), technology changes (HFT and home based retail trading), or business/economic cycles and trends (dot com era, long term american financial growth/decline...etc)

 

I think those 3 types of factors actually can and do change the behavior of markets for large periods of time, and possibly even permanently (like the internet has done).... but the effect of individuals changing the markets as you infer would require a proportionally higher amount of people to either "figure it out" or "go broke" than existed at some previous point in history. And I doubt that this is ever really the case.

 

Access to helpful resources and information has become better, but so has access to a larger amount of misinformation and bad advice. The barriers to entry as a trader have become significantly lower over the past 20 years, but that brings as many more bad traders than good traders.

 

I could go on and on...but I think in the end, what distinguishes some from the rest is that they are flexiable, confident, determined, capable, talented, and deeply desire to be successful traders. And the rest are missing one or more of these characteristics.

 

And I don't think time is a function of it here. As ed Seykota once said something to the effect of: "many are called and few are choosen"

 

Markets can and do behave differently over time. They also always behave the same...just the scale and proportion and ratios of each phase of a market cycle will change.

 

But they don't change because some go broke and others learn. As a species, we reproduce too fast, change too slowly, and die off too often for individual change to somehow add up in the aggregate in a way that alters the way a market rises and falls.

 

FTX

 

I am speaking more about an edge that you may have in the market. It frequently goes stale. It goes stale because the lemmings that you are used to taking money from cease to exist as they were either by learning or extinction. Eventually a new flock comes back, but for a time being the new flock sees that what the old lemmings were doing does not work and won't engage in the activity that gave you an edge. But at some point they will.

 

You too will then have to learn that the edge is not working as it was or perish along with the lemmings since if you can't take advantage of anyone in the market, you will be taken advantage of. If markets were in fact the same all the time, then you would be able to do the same old thing and make money all the time. That type of thinking is holy grailish.

[BlueHorseshoe 10]

I am speaking more about an edge that you may have in the market. It frequently goes stale. It goes stale because the lemmings that you are used to taking money from cease to exist as they were either by learning or extinction. Eventually a new flock comes back, but for a time being the new flock sees that what the old lemmings were doing does not work and won't engage in the activity that gave you an edge. But at some point they will.

 

You too will then have to learn that the edge is not working as it was or perish along with the lemmings since if you can't take advantage of anyone in the market, you will be taken advantage of. If markets were in fact the same all the time, then you would be able to do the same old thing and make money all the time. That type of thinking is holy grailish.

 

"Edge" is a strange word, though I often use it myself. In an idealistic sense, an edge can never be lost because it is a fundamental and immutable true decription of some aspect of market behaviour . . . If you think there is such a description is impossible and markets always change . . . well that is just another meta-theory and you could exploit it as an edge. As Terry Eagleton put it 'not having an ideology is an ideology'. Enough of that though!

 

In the less general sense that you're using the word (with "edge" pressumably more similar to "strategical advantage"?) then I wonder whether what you say is true? Surely in any large and liquid market it is not a question of specific traders evolving or perishing . . . Isn't it more useful to think of other traders in terms of "types"? And if you do this, isn't it easy to imagine that a certain type is always re-populated as its old members perish or evolve?

 

A more concrete example: those who buy breakouts in the ES on 5min charts are not the same traders who bought into these same moves five years ago. Those doing this five years ago perished or evolved. But someone else is doing it today, and I can still take the other side of their trade.

 

All of this kind of feeds back into the topic in my mind as follows:

1. As the lemming's numbers depreciate, so too must the liquidity into which you can lean a money management approach. So whether a class of participants who wise up and are, or are not replaced, is critical to position sizing.
    
   
2. If the proliferation of lemmings across any specific instance of a bunch of markets is random, and lemming extinction is a function of time, then diversification makes sense: the more you diversify the more chance you have of taking the opposite side of a population of lemmings in an ascendent phase . . .
   

 

Christ that got wordy!

 

BlueHorseshoe

[ForexTraderX 10]

I am speaking more about an edge that you may have in the market. It frequently goes stale. It goes stale because the lemmings that you are used to taking money from cease to exist as they were either by learning or extinction. Eventually a new flock comes back, but for a time being the new flock sees that what the old lemmings were doing does not work and won't engage in the activity that gave you an edge. But at some point they will.

 

You too will then have to learn that the edge is not working as it was or perish along with the lemmings since if you can't take advantage of anyone in the market, you will be taken advantage of. If markets were in fact the same all the time, then you would be able to do the same old thing and make money all the time. That type of thinking is holy grailish.

 

Ok Mighty, I see your point, and it has it's merits. The "january effect" is now more like a "january afterthought"... "IPO investing is a great way to wealth", as long as quit investing by around March of 2000, or talk to anyone who facebooked their portfolios. And of course "buy and hold" has been dead for a decade and counting... etc.

 

Also, mathmatically based, statistically valid edges are vulnerable to possible extinction. A chart pattern that works 64% of the time now may not work that well in the future, if it works at all.

 

But there are other, less specific, more conceptual ways of trading that I believe will always remain viable, because their existance is rooted in the very heart of how human beings compete with one another to make a profit in a free floating, auction market model.

Take the concept of "support and resistance" for example. We can measure it differently today than yesteryear, and maybe it works better or worse at different times and in different markets, but if someone bases a strategy on identifying areas of support or resistance...well, it's probably going to work for a good, looong time.

 

Another one is the nature of markets is to be mean reverting. Once a market swing hits a capitulation point where there is simply not enough buyers at that time and price to outbid sellers at that time in price, an upswing will start to turn down. And because humans hate to lose money more than they like to make money, the former bullish winners become losers at a higher frequent and the losses are in greater magnitude as the bear move takes over...thus forcing more selling, etc. Until of course this has exhausted itself again, and starts over the other way.

 

If one identifies a variety of ways to determine this "overboughtness" or "oversoldness" (and not just one. and also not a stochastic oscellator)... and this same person also is constantly looking for new or better tools and methods that help them measure this overbought or oversoldness.... then one now has a strategy or methodology that I daresay has an "eternal edge"

 

Because the individual tools can and DO break down over time, yes. But the "edge" IMO is not the tool, it's the IDEA behind the reason for that tool to exist in the first place.

 

A good mechanic is a good mechanic. Sure, this mechanic like every other will need many tools to do his job, and sometimes, those tools wear out, break down, get stolen, or become obsolete.

 

But are those tools what makes him a good mechanic? I'd say no. It's his experience, his knowledge, his ability to understand mechanical problems and find solutions for those problems. His tools do not provide his "edge". They facilitate the proper implementation of his "edge".

 

And unless the guy has a stroke, or the world of physics and simple machines like levers, wedges and pullys suddenly travels through an alternate universe where matter exists as energy alone (or whatever).... he will be a good mechanic. He will have an "edge" on fixing cars.

 

mathmatically based, statistical edges do come to an end (options trading edges from optiosn mispricing has changed greatly over the last 40 years)

 

market cycle or "flavor of the month" based edges also do end. (dotcom IPO's... commodities during stagflation in the 70s. Buying and flipping real estate in 2000-2006)

 

but edges that are based on market principles don't end. The tools one needs to measure them in detail may change. but these edges don't change. And in this perspective...neither do markets.

 

FTX

 

 

 

 

 

But, conceptual based "edges"

[MightyMouse 12]

"Edge" is a strange word, though I often use it myself. In an idealistic sense, an edge can never be lost because it is a fundamental and immutable true decription of some aspect of market behaviour . . . If you think there is such a description is impossible and markets always change . . . well that is just another meta-theory and you could exploit it as an edge. As Terry Eagleton put it 'not having an ideology is an ideology'. Enough of that though!

An edge is within you. It is your ability to take money from other traders. It is the mental game. More specifcally, it is knowing when others are going to be wrong. You won't find it on a chart or a spread sheet. Do statistical arbitrage opportunities exist? Yes, if you are fast enough to find them. An edge does not occur when line A crosses over line B.

Isn't it more useful to think of other traders in terms of "types"? And if you do this, isn't it easy to imagine that a certain type is always re-populated as its old members perish or evolve?

They absolutely repopulate but you may have to be patient for them to come back; and, yes, I do see them as types. In my opinion seeing them as types and identifying which types are active is critical to succeeding. You need to have a good idea if there are traders who will pay you before you take a trade.

A more concrete example: those who buy breakouts in the ES on 5min charts are not the same traders who bought into these same moves five years ago. Those doing this five years ago perished or evolved. But someone else is doing it today, and I can still take the other side of their trade.

 

All of this kind of feeds back into the topic in my mind as follows:

1. As the lemming's numbers depreciate, so too must the liquidity into which you can lean a money management approach. So whether a class of participants who wise up and are, or are not replaced, is critical to position sizing.
    
   
2. If the proliferation of lemmings across any specific instance of a bunch of markets is random, and lemming extinction is a function of time, then diversification makes sense: the more you diversify the more chance you have of taking the opposite side of a population of lemmings in an ascendent phase . . .
   

 

Christ that got wordy!

 

BlueHorseshoe

 

If you need to make money from trading and can't wait for the lemmings to be repopulated the market, then perhaps you should learn how to trade other markets, but they do come back.

 

The lemming analogy only really goes so far since we are human and not driven by instinct.

[ForexTraderX 10]

An edge is within you. It is your ability to take money from other traders. It is the mental game. More specifcally, it is knowing when others are going to be wrong. You won't find it on a chart or a spread sheet. Do statistical arbitrage opportunities exist? Yes, if you are fast enough to find them. An edge does not occur when line A crosses over line B.

 

NOW we are getting somewhere!! Yes, absolutely. You put into words what I've been thinking about off and on for a long time now, but have not been able to articulate. It's also why I personally don't have any sort of set trading plan that says "step 1: do this, step 2, do this, etc". I don't even have a specific "setup" that I look for. I don't even have any risk management rules other than "don't crash your account today". But your correct when you say "it is knowing when others are going to be wrong". That IS my edge. I use a lot of tools to do it, but it's all about finding a price point where I believe the most amount of traders are going to realize they are wrong in the shortest amount of time, and I put an order at that price.

 

Damn Mighty. Your name suits you.

 

That's why I trade with and against the trend now that I think about it... I didn't know why really until this moment. It's because either with, or against a trend, there will be a point when price stops moving up and starts moving down, or visa versa. That point is always somewhere, regardless of trend. And it's that point that my entire career is devoted to identifying. If i'm right, i'm paid. If i'm wrong, I pay out. Simple as that. I know what types of traders tend to be losers, and how they act in general and how they execute orders going in and out of the market. and I also know how other groups of more sophisticated traders look to identify how losing traders usually place their orders, and they look to trade against them so that they can profit from the other guys losses.

 

That's my edge. It's not always right about it, and that's why I never bet the farm. But i'm right more than i'm wrong, and make a bit more when I am right, than I lose when I'm wrong.

 

And this is why "diversification" in a general sense doesn't make any sense to me. My edge is in finding large clusters of losing traders and bad decisions and rapidly shifting emotions over a relatively tight range of prices. I suppose "diversification" lets me find more of those spots, because different markets have those spots at different prices and are touched at different times. SO in this way, trading more than one market DOES help me make more money. But it does absolutly nothing to reduce my chance of a loss. My ability to find lots of losing traders in a very tight price range is what defines my success and failure.. And my success or failure at meeting this particular objective is completely independent of how many or how few markets or groups or markets or whatever that I"m involved with.

 

My edge is in finding a price where the most amount of people will likely realize they are wrong. My method is any tool that gives me insight as to what price this is most likely to be in any given market, on any given day. The only form of "risk management" that even applies to me is how much I bet on each trade, and how well I'm in control of my actions and in sync with my emotions.

 

In my trading, diversification helps me reduce risk about as well as watching survivor on TV will help me play basketball better. And any other "traditional" form of risk management would really just be a useless distraction.

 

Great summation tho of a real edge. FInally something I can tell people when they ask "how do you make money trading?" I can tell them "I identify a price that I have reason to believe that the greatest number of traders are going to realize that they are wrong, and I take the other side of their trade"

 

FTX