Trades that Have a Quantitative Edge

My approach to trading is based on math and statistics. Every stock pick I make is based on the statistical research I've done. This page gives some specifics about what I've found from my research.

First of all, there are a ton of trading strategies that don't actually have historical profitability. I've tested at least 5,000 different trading strategy ideas against historical data, and the vast majority would not have generated a meaningful profit. One way to interpret this is that overall there appears to be a lot of random "noise" in the market.

Also, when I look at small time frames (like trades lasting just a few minutes or few hours), there is a LOT more random noise than on larger time frames. I found very few trading strategies with clear edges on the smaller time frames. That's a huge reason why I don't day trade; I don't have any statistical evidence from historical price data that shows a mechanical trading approach can generate consistent profits.

Another key realization is that the market's condition has a big effect on which trading strategies have edge. For example, if we're in a bear market, many bullish strategies perform very poorly.

One more over-arching fact we rely on: over time, the U.S. stock market goes up. It's been doing it for more than 100 years. There are certainly periods where it has setbacks, but long term this thing goes up.

Those are the key points of the framework I use for trading.

If there is a lot of random noise in the market, even for trades on longer time frames, you might be wondering what exactly are the edges that I've found. What trading strategies could be used where there is clear evidence of repeated profitability throughout history?

Well this page that talks about my favorite trading edge will give you a lot of insights on one great example. On that page I lay out an example of an edge that has stood up to the test of time, in the form of back tests, and that I feel very comfortable relying on.

That's an example of just one trading strategy in my portfolio. But in general, my strategies "lean long" (which means that I buy more than I short), because according to historical price data, that's what pays off.

And I typically only hold for about a week on average. The reason is because the further out you try to predict the price movement, the harder it is to nail down a probability with any degree of confidence. So my trades are swing trades, but they're on the shorter end of the spectrum typically.

Now keep in mind that when I say these trades having a historical edge, it means that when I run my trade strategies through back tests, they are profitable. When I say I did a "back test", it means that I took my trading strategies and applied them against historical stock market activity to see how the trades could have performed. The results of the back tests are not live trading results. These results certainly do not guarantee future results. See my disclaimer here.

The beauty of knowing that you're trading a strategy that has a historical edge is that it feels almost like you're the house in a casino. The house always has the edge when it comes to slot machines for example. In the big picture, they're going to walk away winners because statistically they have the edge.

Sure, it's true that casinos have some days where a gambler will win big on the slots, and it's a type of "drawdown" for the casino. But they know they've got the edge statistically and that it's a numbers game, and for them over time the more times those slots get played, the more their expected profit is.

And that's what it's like for me when I trade with these quantitative historical edges behind me. I take my lumps every once in a while, just like a casino, but I can rest assured that in the long run I have the edge on my side and that the more trades I make with edge, the more my expected profit is. I can't imagine trading any other way at this point!

Of course casinos have edges built into their systems, so they're likely much more predictable than what I've found in my stock market research. So it's not exactly like the edge a casino has because it probably isn't as predictable. But if there is a price pattern that has repeated over and over throughout history, that to me signifies that the odds would be in my favor at times when it starts to occur in the future.

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