Conceptual understanding will help you build enduring edge.....
Concept comes first then strategy then tactics.
If you are serious about your trading there are some concepts you must know in significant details. Once you understand those key concepts you will stop chasing tactics and will find greater success.
Deep understanding of concepts will help you build a strong foundation on which you can build a trading system. There are seven concepts you should study:
Momentum : If you understand this you will understand trends and mean reversion. You will understand why and how momentum works in the market. Most indicators are momentum based. Trend following and buying strength also works, so does mean reversion. They are all part of the momentum phenomenon. Once you understand momentum you can design hundreds of ways to trade momentum. Billions of dollars are traded and invested using momentum. Momentum is one of the core strategies used by every single quant fund.
Market Breadth: Stock markets are composite markets. The overall move in market is an aggregate of moves of several hundred or several thousand stocks. So the level of participation in a move is important. Market breadth deals with the participation of moves in any market or sector. Market breadth is the basic concept used by every big institutional player to build trading strategies and determine market direction. Once you understand market breadth you will find 500 tactics to make market breadth work. Market Monitor is one of the ways to do that. And there are several ways to do it.
Equity Selection: Because the overall market is a composite of many individual moves, it becomes critical to select right kind of stocks from the universe of 8000 stocks. Hence equity selection is extremely critical. You should know various ways in which one can select equities. Your returns are a function of your equity selection method. If you are trying to make big returns then equity selection is key. You need a equity selection strategy before you can move to next level of trading decision. Most novice traders have no understanding of equity selection concept.
Market Anomalies: Market anomalies are the proven structural phenomenons in the market. If you base your trading on a proven and statistically significant anomaly, you will be profitable. Absent that no amount of indicators will help you. A through understanding of anomalies will give you an edge.In last 40 to 50 years there has been significant understanding of the market in terms of what works and what does not work. Every single thing which you can think of has been tested. If you know what works then you would spend time on it rather than chasing tactics. Most retail and novice traders have no understanding of what works and why. So they are gullible to any tactical claims.
Market Microstructure: Market Microstructure is a branch of finance concerned with the details of how exchange occurs in markets. Understanding this will tell you how the market operates. The concept of market microstructre is very critical if you are trading very small time frames or are a day trader. Because to be successful on those time frame you need to find exploitable anomalies in market microstructure. You need to understand role played by market makers, automated programs, arbitragers, large fund buyers and so on. Their tactics and behaviour creates certain patterns.Quant funds exploit such patterns daily.
Growth investing : Growth investors buy stocks of companies growing faster than the average company in the market. Growth investing is a well established field of study and practice in the market. There has been thorough research on what growth factors work, why they work and under what conditions they work. Many well known traders are growth investors or growth stock traders.
Value investing : Value investors buy stocks of companies which are cheap or out of favor. Valuation has again been extensively studied and there is lot of analysis to tel you what exactly to look for in value stocks. Big funds and hedge funds and institutions are primarily valuation driven. It allows them to put large sums of money to work.
These are the core concepts around which all trading strategies revolve.
Once you understand these core concepts then your next line of study is about trading tactics. Tactics are methods to implement some of these core concepts. Here again certain trading strategies have emerged over the decades like position trading, swing trading, hedging, arbitrage and so on. Knowledge of these concepts will help you understand how and why these strategies work.
Unfortunately most traders start at tactical end. Many blow up their account before they even can understand core concept. Many of you are going to do exactly the same thing.
If you want to become a surgeon would you start your study with what scalpel to use or with anatomy and physiology. If your understanding of core concepts is weak or non existent no amount of scans or software's or indicators or trading psychology or multiple monitors or trading chat rooms or advisory services will help you become a successful trader.
So next time someone talks about a tactics, scan, or a software, or a trade, instead of immediately jumping on it and deciding to learn it, relax, sit back, think. First ask yourself what is the core concept behind this. Is it based on data. Is it logical. Is it really a new new way of doing things or same wine in different bottle.
Conceptual understanding will help you build enduring edge.....
3 comments:
Dear Pradeep,
Very nice post, neatly encapsulating the whole paradigm of the trading process. Would love to hear more regarding your take on profitable momentum dissection and equity selection.
Regards,
Hi pradeep,
could you please tell what indicator do you use to decide whether a particular stock is over bought or not.
Thanks
Renu
rmike
thanks
Renu
I do not use overbought or oversold indicators in my trading. But you can try Stochastic which is used by many traders.
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