Finding One's Edge

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avalok
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Finding One's Edge

Post by avalok »

jacob wrote:
Thu Jul 14, 2022 7:12 am
You have to know your edge, that is, what you can do that few others (only a small percentage) do. A typical edge would be domain knowledge, like e.g. knowing a lot about graphics cards. The tools go along with that. If GPUs are your thing, you're already reading magazines, discussing hardware on forums, ... knowing which are trending. One active investor I know is an anthropologist who looks for cultural trends; what people wear, eat, etc.
This thread was enlightening, and brought home how in over my head I may be when it comes to investing. Now, I could take from this that I should leave well alone, certainly that is the received wisdom. However, I do find this stuff interesting, and would like to continue improving my skills. Unfortunately, when thinking of possible edges I may possess, I am drawing a blank. I appreciate this could be because I don't have one, but would like to remove the possibility of lack of imagination before drawing that conclusion.

I am interested if anyone has thought about finding (or developing) an edge. Is there a way to approach this more methodically than thinking one up?

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Lemur
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Re: Finding One's Edge

Post by Lemur »

A Redditor a few years ago turned a $100k investment to over $3m by just focusing on one stock - AMD. Studied everything about the business, its competitors, and its price movements. Bet big when it went under what they thought was the intrinsic value and even sold calls / purchased puts when the stock was overbought. That was their edge.

Professional fund managers don't have the luxury of just heavily focusing on just one stock. I'm certain that is due to some regulations. But you the individual could put all your money on one stock or 2-3 stocks if you wanted to.

I speculate that a well developed edge might take more then just specialized knowledge of one business but also generalized knowledge of market and industry trends as well. And some knowledge of betting too. Like Poker in a way. Knowing when to bet big but also knowing when to fold.

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Re: Finding One's Edge

Post by jacob »

Keep in mind that execution is just as important as edge. Figure something like edge * execution > average squared.
The Turtle Trader book highlights this problem. Even when given a strategy to follow to the letter, many in the experimental group started making [emotional] exceptions and tweaks to the timing and ultimately lost money.

ertyu
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Re: Finding One's Edge

Post by ertyu »

Lemur wrote:
Tue Sep 27, 2022 2:08 pm
A Redditor a few years ago turned a $100k investment to over $3m by just focusing on one stock - AMD. Studied everything about the business, its competitors, and its price movements. Bet big when it went under what they thought was the intrinsic value and even sold calls / purchased puts when the stock was overbought. That was their edge.

Professional fund managers don't have the luxury of just heavily focusing on just one stock. I'm certain that is due to some regulations. But you the individual could put all your money on one stock or 2-3 stocks if you wanted to.

I speculate that a well developed edge might take more then just specialized knowledge of one business but also generalized knowledge of market and industry trends as well. And some knowledge of betting too. Like Poker in a way. Knowing when to bet big but also knowing when to fold.
on the other hand, overspecialization is a well-documented reason for underperformance. I believe it's o'shaughnessy's what works on wall street where I read this, but when money managers were asked for a very good investment, they did not do that well. they did not do well because they had a bias for the investments they were already familiar with. their results were poor because their field of choices was poor.

there is also a skill in selecting what it is you're going to specialize in - for every person who developed expertise in gme or amd or any other stock that went meme, there's 100 that developed expertise that didn't get them anywhere. there's a lot of survival bias here.

avalok
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Re: Finding One's Edge

Post by avalok »

Lemur wrote:
Tue Sep 27, 2022 2:08 pm
Professional fund managers don't have the luxury of just heavily focusing on just one stock. I'm certain that is due to some regulations. But you the individual could put all your money on one stock or 2-3 stocks if you wanted to.
This is Peter Lynch's recommendation IIRC. It makes sense to me, and is a "safe" bet in that if one is willing to put in the time, you will likely find a handful of stocks that are (a) not well covered by institutions (b) likely to be performant. My concern with this is exactly that which ertyu raises; you shoulder a lot of risk by specializing. Perhaps this is something to do with more trivial amounts of capital?
jacob wrote:
Tue Sep 27, 2022 2:19 pm
Keep in mind that execution is just as important as edge. Figure something like edge * execution > average squared.
There must be a weighting toward edge though. That edge must count for more than execution, else no edge and the superb execution would be a sound strategy... wait, isn't that passive investing? :lol:

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Re: Finding One's Edge

Post by Dave »

avalok wrote:
Wed Sep 28, 2022 4:23 am
There must be a weighting toward edge though. That edge must count for more than execution...
Over time I've come to agree with the importance of execution over/equal to "edge" more and more. It seems like having an edge would make the whole thing simple, but that's not the case in my experience.

It's like this. You find an asset that is cheap. Great. You'd think it would be as simple as buying it, waiting for it to go up, and then selling as it approaches or exceeds fair value.

In reality, though, managing a portfolio is often not like this. You're going along doing research and find something you really like, trading at 50% of value, which gets you excited (i.e. greedy). However, you don't have meaningful cash, so to buy something new, you have to sell something else (that you were previously just as excited about, maybe trading at 80% of value now). Say the thing you sold runs another 15% up and the thing you buy falls 15% down and takes a year to get back to the purchase level before going on to perform well. You could be right, but the execution of your exit/entry has a material impact on your actual performance. Rather than letting your initial idea play out, you prematurely ended the trade because you got excited about the cheaper stock.

Consider a counterfactual where you held your original stock for another 6 months, it went up 10%, and then you sold to buy the new stock that went down another 10%. You've now realized a larger profit, can roll that larger profit into a now-cheaper stock, and you've cut out 6 months of the flat time of the new purchase. I've had this situation play out time and time again.

It is fairly common that value investors sell assets too soon (i.e. they keep going up post-sale) and buy assets too early (they keep going down post-purchase). I'd say this is an execution mistake. I've always done fairly well at identifying cheap stocks, but less well at optimizing the trading element. Focusing on correcting this mistake has yielded greater returns for me than finding cheaper stocks.

If you read books like Market Wizards you'll see this idea pop up, too, in types of investing/trading other than value investing. Someone has a good strategy, but doesn't execute it well as they get swept up by emotion and alter the approach.

It sounds like an odd thing when you're starting out as you think it's just a matter of finding "the right approach". But you come to see it's as much about consistently executing a solid approach as it is finding the "best" approach.

Livermore's quote encapsulates this idea well with respect to my own mistakes:

“Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after a stock operator has firmly grasped this that he can make big money. It is literally true that millions come easier to a trader after he knows how to trade than hundreds did in the days of his ignorance.”

To generalize this quote, we could say:

"Individuals who can identify alpha-producing strategies and strictly adhere to them are uncommon...It is literally true that larger profits come easier to an investor who strictly follows a sound strategy rather than hopscotching around all the time to the whims of their emotions."

avalok
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Re: Finding One's Edge

Post by avalok »

@Dave this is a fantastic explanation: it has scratched away at my misunderstanding of what execution entails. Suggests it is just as (if not more) important to focus on one's character (specifically the ability to stick to an approach; discounting emotion) than to be able to find bargains.

An explanation by Jacob I discovered recently comes to mind:
jacob wrote:
Sat Sep 07, 2019 1:27 pm
What's the lesson here? What Jason is saying ... the most important thing to know in investing is yourself. This is why many traders spend time studying Musashi, Sun Tzu, or Jesse Livermore or other traders rather than the minutia of 10Ks, etc. I think most retail investors would be surprised to learn that the so-called professionals who are ascribed immense powers are often mid-twentysomethings with all kinds of backgrounds other than financial analysis. I guarantee you that some of them don't know what a P/E ratio is on their first day of work. They're more likely to be picked because they're good at poker or have an "interesting" background (like say maybe an expert violin player or an ex-Olympian).
This then ties back in nicely with the emotional goals of the renaissance lifestyle. The more skillful one is in that domain, the better their execution can be.

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grundomatic
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Re: Finding One's Edge

Post by grundomatic »

I want to change my investments. From the inside, how do I tell if I am appropriately adjusting to changing conditions (market and mine), changing the way I think about investing, or just changing the plan willy-nilly?

7Wannabe5
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Re: Finding One's Edge

Post by 7Wannabe5 »

@grundomatic:

I think it would be roughly analogous to knowing whether you are buying different groceries due to health concern/seasonal pricing vs. improved cooking skills incorporating new/different ingredients vs. feeling bored and hungry, "Hmmm... new flavor Cheetos!"

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grundomatic
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Re: Finding One's Edge

Post by grundomatic »

@7w5

That's a very useful analogy, if accurate. I wouldn't be worried about my grocery list changing from 5 years ago because different ingredients are now cheap enough to actually use, nor would I worry that the master chef has a better list than me. Thank you.

ertyu
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Re: Finding One's Edge

Post by ertyu »

Dave wrote:
Wed Sep 28, 2022 1:33 pm
Over time I've come to agree with the importance of execution over/equal to "edge" more and more. It seems like having an edge would make the whole thing simple, but that's not the case in my experience.
Another take on what matters most, this time from Harley Bassman:
Remember: For most investments, sizing is more important than entry level.
It's very interesting to hear this from someone like Bassman whom I consider to have a lot of market wisdom. Would you consider sizing as part of what you term "execution"?

Dave
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Re: Finding One's Edge

Post by Dave »

ertyu wrote:
Tue Nov 29, 2022 3:43 am
Would you consider sizing as part of what you term "execution"?
The way I think about it, yes.

But it depends on how you define edge and execution. I've always thought edge is about finding some sort of trade that has positive expected alpha, whereas execution is all of the portfolio management behind implementing said trade (when to first buy, how much to buy at first, how much to buy later, how long to hold, how long until first sales, how long until final sales, how to size relative to other trades, etc.) In other words, edge is "what to trade" and execution is "how to trade". But that's just how I think about it, and I've heard others use the terms a little differently.

For example, one could argue they have an edge is in superior position sizing of various trades - better risk adjusted trades are sized up and worse risk adjusted trades are sized down. Or they have superior timing in entering and exiting positions. You sometimes hear people talk about this as a "behavioral edge", and in fact I think this is the area I have improved upon most, more so than getting better at running more accurate DCF's/identifying cheaper stocks/understanding new businesses quicker & deeper.

I don't want to overemphasize execution, though. Edge matters, too. A lot of it comes back to circle of competence, keeping yourself out of trouble, and playing to your strengths. I am a low AUM solo investor with very limited access to top data/expert networks/management teams and I don't have a top-tier IQ, so I try to do best what I can, which is being emotionally stable and patient and waiting for the market to serve up no-brainer (to me) situations to act upon in both directions. But if I was managing $100M and had better data, tools, and was smarter, I may be more interested in testing/developing various edges that generate alpha. I just don't see that as particularly fruitful for my overall situation.

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