The Seven Edges of Big Money Traders

The biggest traders in the market across all asset classes, what were some of the characteristics of their success, what was some of the characteristics of how they traded? I created out of that was called The Seven edges of big money traders, and we're gonna go over that today.

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This is a workshop that I partnered with Dr. Van Tharp a couple years ago, to teach students about how big money traders, how the biggest traders in the market across all asset classes, what were some of the characteristics of their success, what was some of the characteristics of how they traded? I created out of that was called The Seven edges of big money traders, and we're gonna go over that today. The seven edges of big money traders are 1.) expertise in a market or in a strategy, 2.) trade with edge to fair value, 3.) trade with positive reversion, 4.) use flows to make trading decisions, 5.) identify asymmetric trade setups, 6.) manage risk through spreads and relative value, and 7.) use instrument selection to choose the optimum strategy to maximize your trade idea.

Number one, expertise in a market or in a strategy. If I go amongst all my friends that are successful traders. Most of them are an expert in a market. There's one market that they know really, really well that they know everything about, that they know more about than virtually anybody. I have friends who are experts in natural gas, experts in crude, experts in soybeans, experts in corn, experts in sugar, experts in the VIX, experts in treasuries, particularly like the 10 year note. I could go on and on. They're experts in a market. One of the advantages of being an expert in a market is experts in markets are usually consistently profitable, they make money virtually every year. The drawback to it is, they have high variability in their profits, they kind of have a baseline, that if the markets normal or quiet, they'll make a certain amount of money. But if the market is busy, their p&l will explode. It's not uncommon for somebody, let's say to make a million dollars a year, in a normal year to make 10 million in a busy year. That happens, okay. But if that trader goes out and tries to make $10 million every year, in that market, he won't make it. Because the market conditions are not there. He'll make money all the time, but his variability will be all over the place.

Then there are traders who are experts in a strategy. They have a strategy, they have a pattern, they have a method, and they port that to different markets that are meeting the criteria of their strategy. They may trade coffee today, they may trade Microsoft tomorrow, they may trade Intel the next day, they may trade Halliburton the following day. They're going from different sector to different country to different asset class, and they don't really care as long as it meets the criteria of their strategy. Now, people who trade this way, first of all, there's less of them, it's harder to do, but the people who use this technique or this approach, they can make a lot of money all the time, because they are always in a hot market, and the hot market will pay. Now, the drawback is people who trade this way is if you go through a period, kind of like we're going through right now, where, let's say they're a trend follower of some sort, and there's very few trends so they'll make money but they won't make as much, and if they're not aware that the environment shifted, they might lose money, they might lose it all.

You can be an expert in a strategy. You can be an expert in a market. When you go look at great traders they are an expert in something. That's why they are big money traders. They're not mediocre, they're not okay, they're not good. They are outstanding. They are an expert.

Number two, trade with edge to fair value. Big money traders actually know what the fair value is of what they're trading. Most traders have no clue what they're fair value is, but really good traders have a sense of what the fair value is, and they work to buy under fair value, and they work to sell over fair value, getting an edge every time they make a trade, and they understand that with fair value, that fair value can be stable, where it doesn't move very much, and prices oscillate around that fair value, or fair value can move or what we call migrate, and when fair value migrates, then you'll know that it's migrating and you'll pay a higher than you would have today, but you'll still buy under what fair value is, or you'll sell over it, and they know what migrating fair value means for the market. They have a strong understanding of what fair value means.

Three, they trade with positive reversion. This means that they buy low and sell high, it's similar to two, but it's a little different. They're buying low and they're selling high, they're always trading at the lowest cost, the lowest interest rates and the lowest amount of slippage. The average trader has no concept about this. They're buying high entering on a stop, and then they have a trailing stop. When you exit on the stop, you're selling low, you're selling the bid, you're selling the lowest price at that time. If you have a system that buys on a breakout and sells on a trailing stop, you have negative reversion, and this adds up. I did a Facebook live on this this week, it's not uncommon for this to cost you 2R per trade, 1R getting in and1R getting out. Imagine if you're behind 2R in every trade. That means you have to make 2R just to get back to breakeven. Well, of course, it's gonna be really hard to trade and make money. But when you look at big money traders, they buy the bid, they sell the offer, they're picking up 2R buy, you're paying it, they're picking that up. Imagine how much better you would trade if you've got a 2R credit from the beginning, every time you trade it, that would make your path much easier.

Edge number four, using flows to make trading decisions. When you go look at Bank traders who go look at algos, they seem like they're superhuman intelligence, superhuman programs. People think that bank traders or hedge fund managers or prop traders that they are brilliant, and they are, but there's something else that's really going on, and that is that they see flow. They know the order flow coming into a market. If you knew somebody was going to buy 50,000 SNPs in the next 10 minutes, wouldn't be that hard to make money. You could buy now, let them buy their 50,000 and then slowly sell it to them, and you'd make money. Because all you had to know is somebody had to buy 50,000 This is what buying flow is. Flow is being able to see the orders coming into the market and being able to trade ahead of them or alongside them in correlated products. So many big money traders just have order flow. That's why firms pay millions, if not billions of dollars for the rights to order flow. A firm like Citadel securities, they pay billions of dollars for order flow because they monetize it, and they make billions off of it. It's a huge edge. It is the primary edge. It is the most desired edge for anybody in the bank or prop space.

Five, identify asymmetric trade setups. You've probably heard me talk about this in the past. This is where we have a chance to make much more than what we can lose. The rule of thumb we always use is you need to be able to make at least three times what you risk and preferably five. Big money traders wait. They don't just trade to trade, they wait until they have asymmetry on their side, where they know that they can make 5X, 10X, 20X, 50X their risk if they get it right. They don't have to get it right very often when they make that much. They just wait. They don't trade to make $1 risking $1. They trade to make $5 risking $1. This is one of the secrets of trading and this is one of the 10 Irrefutable Laws of Success. Get this right and your trading will change.

Six, manage risk through spreads and relative value. You go look at all retail traders and they're directional traders who buy or sell a stock or buy or sell crypto or buy or sell a future. That's it, it's so many. The pros I know, the majority of them, trade spreads and relative value. We go back to edge number two, which is trading with edge to fair value. One of the ways they do this is that they use spreads and relative value, and they can calculate what a fair value is by looking at spread relationships and relative value relationships, and then what do they do? They buy under that fair value, and they sell over that fair value, but they also manage their risks. You have much less risk, when you have a spread on. You have much less risk, when you have a relative value, relative value really is a spread. It's like buying one selling another. This one's cheap. This one's expensive. Well, lets buy this one. Sell this one, and when they revert to fair value, we make money. The majority of traders I know, that are really great, this is what they do.

The last edge is using instrument selection to choose the optimum strategy to maximize their trade idea. This is what you hear me talk about all the time with options. Like I just said, they don't just buy a stock and hope it goes up. They buy a pair, they buy a basket. They do something in which they have their risk spread, and then they hope they get outperformance from one of those legs. That's one way where a spread outperforms an underlying. Another way is that an option strategy or an option spread outperforms a spread or underlying.

One of the reasons I call my business the Trading Matrix is there's a whole matrix of possibilities of what I can choose to express my idea, and usually just buying a stock to go up or selling a future to go down is the worst one, the worst. You can come up with something so much better, and when you look at big money traders, they're looking at this matrix and they're choosing the optimum strategy. This is why they kick your ass. You go and have a great trade, and you're patting yourself on the back because you made 3R like yay, I made 3R there sitting over there haven't made 12R on the same idea that you had on because they are masters at instrument selection. These are the seven edges. If they're new to you, I encourage you to go study these because there is a ton of edge and wisdom and understanding these edges.

I will see you next Tuesday when I come to you with another webinar, to continue to show you different ways to trade to take your performance to an elite level. I'll see you next week. Bye.