What is your Edge ?

WHAT’S AN EDGE? 

In a probabilistic arena such as the markets with random outcomes, an edge is defined as a higher probability of one outcome occurring over another. Edge also represents some type of advantage over time.

There are various type of edges

1) Education and experience give an advantage or edge

2) There is the information and experience edge.

3). Speed  - Robotic computers located very close to exchanges. They try to extract the technological edges.

There are actually many types of edge in the market, but we are going to focus on two edges that are there are embedded in every above edge or are very structural to market.

First one is Win-rate edge and second one is Winning Dollars edge,

Win-rate: This is the % of favorable output over a series of trades.

Most of the Casinos and professional traders use the 50 percent threshold as a baseline to assess their win rate, because a 50 percent win-rate equals probability of flipping a coin, A win rate less than 50 percent indicates a negative edge while a win rate above 50 percent represents a positive edge.

In the roulette wheel in Casion, the House holds the Win-rate edge over the gamblers 52.7% vs 47.3%,  There are 18 red slots and there are 18 black slots and there are two green slots 0 and 00. These two green slots are always for the Casino. So if you bet on say Red slots then your probability is 18/(18+18+2) i.e 18/38  = 47.3 %  So the win rate of casino is 52.7%.

For a new trader, the methods he selects for entry and exit of stocks /etfs should give him more than 50% win-rate to start with. With that said many professionals traders, have win-rate of less of 50%.

many professional traders post win rates les s than 50 percent, which

means they lose money on a larger number of trades than they win. These professional traders understand the importance of edge over time and how the win-rate edge is just one component in their trading plan.

Winning Dollar Edge

Professionals traders give higher importance to the winning dollars edge. Winning dollars edge refers specifically to the reward-to-risk relationship in dollar or point terms of a setup. For example, lot of traders try to seek 2 to 1 or 3 to 1 reward to risk ratio. This means that every $1 risked, the traders is seeking $3 in profits.  So with a win-rate of 50%, this trader over 10 trades would make $15 (5 winning trades x $3) and would lose $5 (5 losing trades x $1) and would make $10.

A combination of these two edges would give you your expectancy numbers. Expectancy number is average amount of dollars you expect to generate per trade.

Expectancy =  (Average Winning dollars x Win-rate)  - (Avg losing dollars * (1- Win-rate))

Once you understand this then you have to work systematically towards either increasing your win-rate edge or your winning dollars.edge,