There is an important relationship between trading edge and trading psychology. Let's explore.
Consider three sources of trading advantage:
1) Directional movement – We find patterns and relationships in the markets that lead to directional trading of the asset. An example of this is a breakout movement that results from a news catalyst.
2) Relative motion We find patterns and relationships in the movement of one asset relative to another. An example of this is trading the relative value of rates, where we might expect the yield curve to slope due to inflationary pressures in the economy.
3) Absolute movement We find patterns and relationships in asset fluctuations. An example of this is an options trade that makes money if the markets remain in a relatively calm range after a volatile period accompanied by significant options deviation.
A rough analogy would be the different ways of scoring for a basketball team. Against a man-to-man defence, there may be opportunities to drive lanes and exploit the inside game. Against a two or three zone defense, there may be opportunities to move the ball on the perimeter and take advantage of cross-court passes on the outside play. In the face of a slow defence, there may be opportunities for long passes and quick attacks to lay the ball down. The point is that no successful team has one way to win. They understand the environment they are operating in and then run plays that exploit that particular situation.
This is how it is in trade. There are times when markets are cyclical and the relative movement can be exploited. There are trend periods that require directional trading. There are also noisy and quiet periods that give way to edges in the volatility space. A large number of trading opportunities occur when environments change and participants are caught playing the old game rather than changing their offensive alliances.
Great traders, like great sports teams, have multiple ways to win under different conditions and conditions. When traders lack adaptability and trade with limited sources of advantage, they find that what worked one period of time suddenly no longer works. This leads to frustration, and can lead to bad trading later.
In-depth reading:
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