2 Ways To Gain A Positive Expectancy (Edge)
There are two ways most traders achieve a positive expectancy (get the probabilities in their favor). These can be used separately or together to gain an edge but the logic is simple – You either FOLLOW THE TREND or trade using CONFLUENCE.
One is not better than the other. Like anything in trading, it just depends on how you do it. Does it suit you and does it work for you? Simple!
Let’s look at trend following first to determine how this helps you achieve a positive expectancy and how you can expect to take advantage of trends in your quest to find an edge.
The Trend is your friend… But Why?
Most of you, if not all of you, reading this article have heard the term “The trend is your friend, till it ends” during your trading journey. I think it’s important to understand exactly why this is true before we can begin to apply it in our own trading.
To give you all a simple idea that you can use to understand this ancient saying is one of Newton’s laws of motion. If I’m not mistaken it goes something like “An object in motion will remain in motion unless acted upon by an external force” (Forgive me if it’s not entirely correct, I am paraphrasing).
If we listen to those words, if we really soak them in, we can safely assume that if price is moving in a certain direction, it will keep moving in that direction UNTIL an external force acts upon it.
For EXAMPLE – If we determine that price is in an UPTREND (It is creating higher highs and higher lows), there is a high probability that price is going to continue making Higher highs and Higher lows and vice versa.
So with that same logic, any trader that is trading in that direction has a higher probability of success compared to the person trading against it or with no regard for it.
They have put the probabilities in their favor and created a positive expectancy (edge) within their trading.
This is why a lot of traders find it easier to only trade with the trend. You increase your chances of being profitable by simply betting that price will go where it’s ALREADY going!
For price to completely reverse and break the trend takes a special effort from the opposite side of the market. But it does happen so don’t fight it in those cases.
This might seem oversimplified and obviously, you still need a strategy/system that determines exactly how you are going to extract profit from the trend you’ve identified. However, trend trading is far easier than the following method.
Why? It takes more effort and discipline which are two characteristics that are not common to newbie traders, which brings me to my next way, CONFLUENCE.
Can I get an Amen for confluence!
I think one of the best ways I’ve heard confluence described was like this. If you’re married or in a relationship, and you ask your partner what he/she thinks about something. When they agree with you, that confirmation makes it a lot easier to carry out your task and assures you that your thinking/approach is likely the correct one. Because your wife/husband thinks that too.
Equally if they say no or disagree with you, you might rethink your approach and figure you might be wrong.
Confluence works the same way. Confluence is the combination of different analyses and/ or indicators to confirm the probability of a buy trade or a sell trade.
Instead of using the probability of a pre-existing trend to make our decisions. We combine different styles of trading and figure that if most of these different trading approaches are printing buy signals, then right now must be a pretty good time to buy.
For EXAMPLE – You open up your laptop or your phone and as you are preparing your charts for the week ahead, you notice something peculiar.
- On a certain pair (it can be any currency pair) you notice price at the bullish 61.8 retracement level on your Fibonacci.
- You also notice price is hitting support on your bullish trend-line.
- You ALSO notice price is hitting a horizontal key support level.
- Not only that, but you ALSO notice stochastics is signaling price is oversold.
If you ever saw these different signals printing at the same time, the probabilities of price bouncing at that particular level are pretty high. WHY? Because all these different trading approaches (Fibonacci, Trend-lines, Horizontal levels, and stochastics) are telling you the same thing… That it is time to BUY.
Following this process is not easy, especially for new traders because you have to recognize all these other signals and put the puzzle together. Outside of that, you need to wait until everything lines up and all your ducks are in a row.
Sidenote – Trends can also be used to confirm buy or sell trades.
Don’t bet the farm.
Don’t lose your shirt.
Cut the L.
Keep the W.