If you're new to trading, you may have come across terms like "trading strategy," "trading system," and "trading edge" without fully understanding what they mean. In this article, we'll explore the differences between these three concepts and how they relate to each other.
What is a Trading Strategy?
A trading strategy is a set of rules that a trader uses to make trading decisions. It's a general approach to the markets that can be applied to different assets, timeframes, and market conditions. Trading strategies can be based on technical analysis, fundamental analysis, or a combination of both. They can also be discretionary or systematic.
A discretionary trading strategy involves making trading decisions based on a trader's judgment and experience. In other words, the trader is using their own intuition to determine when to enter or exit a trade. This approach is highly subjective and can be influenced by emotions such as fear, greed, or overconfidence.
A systematic trading strategy, on the other hand, is based on pre-defined rules for entry and exit signals, position sizing, risk management, and other aspects of the trading process. This approach is more objective and can be backtested to determine its effectiveness. A good day trader will use a hybrid systematic-discretionary approach to their trading. This is the style we teach in the Options Mastery Course and through the One-On-One Mentorship Program.
Examples of trading strategies include earnings gaps and opening range breakouts. Each strategy has its own set of rules for identifying trading opportunities and managing risk.
What is a Trading System?
A trading system is a more specific implementation of a trading strategy. It involves a set of pre-defined rules for entry and exit signals, position sizing, risk management, and other aspects of the trading process such as trade review and trade playbooking. Trading systems can be automated or manual, and they are designed to remove or reduce the human-emotional impact of the trading decision-making process.
An automated trading system uses computer algorithms to generate trading signals and execute trades automatically. This approach can be useful for traders who want to take advantage of market opportunities 24/7 without the need for constant monitoring. The vast majority of retail traders do not use an automated system.
A manual trading system, on the other hand, relies on a trader to execute trades based on pre-defined rules. This approach can be more flexible and allow for more discretion in decision-making.
Examples of trading systems include a strategy like the Opening Range Breakout, and then a personal methodology for how the trader applies the strategy. This will include things like how much risk to put into each trade, how to judge the quality of the trade, on what days to deploy the strategy, as well as any review processes. If you need help developing your own profitable trading system, sign up for the Options Mastery Course.
What is a Trading Edge?
A trading edge is a unique advantage that a trader has over the market, which allows them to consistently generate profits over time. One key element of a trading edge is positive expectancy, which is the likelihood of generating profits over a large number of trades or bets, on average.
In trading and gambling, a positive expectancy is achieved when the expected return on each trade or bet is greater than the expected cost, factoring in the probability of winning or losing. This means that even if individual trades or bets may result in losses, the system or strategy is expected to generate profits over time.
For example, a trading system with a positive expectancy might have a higher profit target than stop-loss level on each trade, with a success rate greater than 50%. This is the trader’s edge. Having a trading edge is important because trading is a zero-sum game. For every winner, there is a loser. Therefore, in order to make consistent profits, a trader needs to have an edge that puts the odds in their favor.
Examples of trading edges include a deep understanding of a particular asset class, access to exclusive market data, or a proven track record of successful trading. Whatever the edge may be, it should be based on a trader's unique strengths and abilities.
Having a positive expectancy is important for traders because it allows them to make informed decisions about the risk and reward of a particular trade. By understanding the probability of winning or losing, and factoring in the costs and potential returns, traders can make more rational and profitable decisions over the long term.
Conclusion
In summary, a trading strategy is a general approach to the markets, a trading system is a specific implementation of a trading strategy, and a trading edge is the factor that gives a trader an advantage over the market. By understanding the differences between these three concepts, traders can develop a more comprehensive and effective trading plan. Remember that trading is a never-ending learning process, and it takes time, patience, and discipline to succeed.