How To Find A Trading Edge Through Momentum And Mean Reversion

Whether you're trading currency or digital tokens, to achieve success you need to have an edge. Without an edge, it's difficult to realize market-beating returns and/or become a profitable trader. 

The edge can take many forms. It could come from better sources of information, speedier execution, enhanced trade management, superior exit signals or a combination of all of the above. 

Either way, one way to summarize it is this equation: (Average Win × Percentage Of Profitable Trades) + (Average Loss × % of Losing Trades). It's important to remember that trading is associated with high risks even with an edge. A positive mathematical expectation does not guarantee future profits.

Nonetheless, all the activities traders engage in, including trade selection, thesis generation, risk management and use of margin, are in support of making sure that calculation is positive. Once you find and fine-tune your edge, there's no need to change it unless it stops working, or you find a better advantage. You can deploy it from one trade to the next – but first, you have to find it.

How To Find Your Edge 

Knowing you need an edge and finding it are entirely different things. The latter can be difficult, requiring trial and error, deep research, learning and meticulous planning. After all, you aren't the only trader looking for an edge. The market is extremely competitive, with traders responding to information at breakneck speed. Outsmarting rivals is hard but not impossible. The markets are driven in large part by two forces: momentum and mean reversion. Within them, it's possible to find your edge.

Take momentum – traders can gain an edge by utilizing bull flags, bear flags and pennants to identify entry and exit points. All three are technical analysis chart patterns that calculate where a current price is likely heading. A bull flag signifies an upward trend, while a bear flag implies a downward trend. Meanwhile, a pennant implies a consolidation phase. They all occur based on momentum and can give traders an edge by providing visual signals of the potential for patterns to continue. 

Traders can get an idea if a strong trend upward or downward will resume after a brief consolidation period. That increases the likelihood of success when entering and exiting trades. In essence, these chart flags help traders predict the direction of a trend and execute trades based on that. 

Momentum: Tried And Tested Edge 

But looking for momentum patterns alone isn't enough. Traders who have an edge ensure that momentum and consolidation are preceded by a real catalyst in a favorable environment and not just random noise. Pairing these together can greatly improve edge, instead of simply looking for momentum patterns everywhere and at all times. 

It's a trading edge embraced by Kristjan Quallmagie, a famous and successful trader who focuses on precise entry points by leveraging market catalysts. Quallmagie trades momentum patterns only when the broader market is healthy and the trade has a strong catalyst behind it. He doesn't react to noise, understanding his edge comes from paring the momentum with research and analysis to back it up.  

To make sure a momentum trade is more than noise, traders rely on the Expectancy Ratio. It’s a key metric used to measure the performance of trading strategies. With it, traders get an idea of how much they stand to make or lose on average based on their trade. Knowing the Expectancy Ratio helps traders decide which trading strategies to execute.

To learn how to get your edge with Octa's online trading platform, click here.

Betting On The Opposite 

Mean reversion is momentum's opposition. If the momentum doesn't have consolidation and is not driven by news, the likelihood is the value will revert. Traders can use that information to their advantage by playing the opposite side of the momentum move. Mean reversion is a proven way for equity traders to carve out an edge. Stock investors have a tendency to often overestimate or underestimate the value of the news released by the company. Traders who identify these poor momentum candidates can take the opposite view and profit from their return to value. 

Mean reversion can also be used in the Forex market. The collapse of the Japan carry trade is a great example of that. A carry trade is a strategy in which a trader borrows money in a currency that has low interest rates and reinvests that money in higher-returning assets elsewhere. With low interest rates and currency, the Japanese yen was a favorite for this play for years. 

Until it wasn't. Japan's central bank eventually raised interest rates, sending the yen higher. Suddenly, traders who borrowed yen had to pay it back at a much higher rate, which sent the global markets into a tailspin. The Japan carry trade had a large influence on the USD/JPY pair and was an excellent trading opportunity for mean reversion traders.

Whether you want to use your edge to trade on momentum or mean reversion, it requires a trading partner that empowers you. Octa, the online brokerage serving Southeast Asian traders, fits that bill. It provides Forex traders with speedy, minimal slippage and a deep suite of professional trading tools. You can take advantage of its modern trading platform, OctaTrader, featuring in-depth charting functionality and expert analysis in theSpace feed—all to help you fine-tune your edge. To learn more about Octa, click here. 

Disclaimer: Trading involves risks and may not be suitable for all investors. Use your expertise wisely and evaluate all associated risks before making an investment decision.

Featured photo by Garun Studios on Shutterstock.
This post contains sponsored content. This content is for informational purposes only and is not intended to be investing advice.