The Risk of Trading: Mastering the Most Important Element in Financial Speculation

CHAPTER 4

Statistical Edge and Its Impact on Risk

Throughout the book so far, the term “edge” has been referenced several times. Statistical edge, mathematical edge, trader's edge, everything edge. Traders use the term quite often as a synonym for advantage. When referring to specific trade setups, edge is used to define any trade that has a greater than 50 percent (perceived) chance of reaching a certain price target, or having one outcome occurring over another during a valid sample of trades. Corey Rosenbloom, a successful trader and author of The Complete Trading Course (John Wiley & Sons, 2011), uses the concept of edge as a dominant principle in his trading success. Risk theorists and data-analytical traders base their trading plans on a similar theory. Rosenbloom defines edge as the “inherent price levels that a pattern provides as an entry, stop-loss, and target, where the target is always larger than the stop-loss.” In his definition, notice how the author incorporates the element of risk-to-reward into his defined criteria to allow you an edge in your overall success as a trader and not just on any given trade. In summary, you can have a statistical edge on any given trade but can have your account depleted if the elements of risk and reward are not properly incorporated into your trade decisions.

Let's look at the following example comparing generic edge on a trade, its impact on trade outcome, and your overall success as a trader. For this example, outlined in Table 4.1 ...