Building an Edge: Don't Diddle in the Middle
When you’re in the midst of trading, a good phrase to remember is “don’t diddle in the middle.” This means you shouldn’t involve yourself in the ‘middle’ of the market and only trade in high-value areas. Trades in these areas produce the highest-quality trades and will be very friendly to your trading account. Other types of trades may not be.
First, let’s define what an edge is. In simple terms, an edge in trading is a system that produces a profit in the long run, due to a built-in statistical advantage. If we’re trading with a system that has an edge, we will make money in the long-term.
We can find our edge by backtesting our system over past price action. It’s impossible for a trader to be profitable if they don’t have an edge because they will lose money in the long-term. The market is very good at throwing you off your course if you don’t have a system with strict rules to follow.
Now, let’s see how we can avoid diddling in the middle and only take trades from high-value areas:
Take a look at this 1-hour S&P500 chart:
The blue zones are supply/demand zones. They identify high-value areas where price is likely to pause or reverse. Here, we see that price has gone down very sharply into our supply zone.
If we assume it’s oversold, it’s a good area to take a reversal trade. We can buy at the current level, place our stop loss just below the zone and place our profit target at the next zone above. It would look something like this:
This is a 2:1 risk/return ratio, which is great. Let’s see how the trade plays out:
Our theory proved correct. Price did indeed bounce to the next zone and hit our profit target. Now, let’s say we didn’t get in at that price and waited until it already moved up a lot. Should we get in? It would look something like this:
Same stop loss and profit target, but our risk/return ratio is much worse (0.75:1) because we got in at a higher price. We still made money, but the trade had way too much risk.
These types of setups are low-quality and won’t make us money in the long-term. The problem is you’re not trading in a high-value area. These are supply/demand zones in my trading, but they may be different for you. They could be trendlines, support/resistance, Fibonacci and more. The point remains: respect these areas and don’t try to take trades outside them.
If price is not in these areas, we’re diddling in the middle. These are bad zones for trades because you need to risk more and get less return. They produce low-quality trades that will dull out your edge over time. If you want to get the most out of your system, seek out only high-value areas and A+ setups according to your system.
Don’t forget the memorable phrase - don’t diddle in the middle!
Disclaimer: Any content from this newsletter should not be taken as financial or investment advice, but for informational and entertainment purposes only. This newsletter simply shares my personal opinions. Investing in stocks, bonds, futures, options, and other securities carries significant risks. Some or all capital may be lost. With leveraged instruments, losses may exceed initial capital. Past performance of a security does not guarantee future results. Consult with a registered financial/investment professional. This newsletter and its authors are not licensed financial/investment professionals. By reading and using this newsletter, as well as any other publications, you are agreeing to these terms.