This post is the next in the series “Using Quantifiable Edges to Your Advantage“. The first few posts examined how I lay out the studies, and what I look for when examining results that would make a study compelling. Today I will touch on what it means to have a compelling edge. Does it justify a trade? What if multiple studies appear to contradict each other?
First I should say that one of the biggest misconceptions about the studies I post on the blog is that they are market calls. They are not. They simply examine market action or conditions from one narrow perspective. It is rare that I would enter an index trade based on a single study. More often it is a combination of studies that helps provide me the confidence to put capital at risk.
I use studies as many traders use indicators. It is rare that someone might see all of their indicators line up perfectly at the same time. Often price action may be suggesting one thing, while breadth, or sentiment, or intermarket action may be suggesting something else. The tool I use to help me weight my studies and determine a market bias is the Aggregator. The basic method of the Aggregator is that it takes estimates from any studies I consider open and active, and combines them into one estimate. A more detailed description of the Aggregator can be found in this post below from 2008.
But information about market tendencies that suggests compelling edges are useful for more than just index trades. No matter what securities you deal in, it helps to have a market bias. A bias doesn’t have to be formed mathematically, but by taking a reasoned approach traders can incorporate information from Quantifiable Edges, as well as other sources, in helping to establish their market bias. I’ll discuss this concept in more detail in a future post. The takeaway today is that a single study is not a market call, but rather a somewhat narrowly-focused examination of market tendencies. It’s a piece of the puzzle. A useful piece, but still just a piece.
And for my money, even if there is a combination of studies strongly suggesting a directional move, I still need to factor in risk/reward. I also need to consider what would constitute a trigger. My next post in this series will examine how I look at overbought/oversold and the role that plays in determining risk/reward. And hopefully by the end of the series I will be able to clearly demonstrate how narrowly focused studies can be used as part of a solid foundation when building your trading plan…or how experienced traders can incorporate them to improve an already solid trading plan.