It’s no secret that financial markets are getting more and more efficient and therefore more difficult for the average trader. So it’s a good idea to think creatively and consider what might lead to an edge today or in the future. If you don’t have an edge you can’t make money.
Here are 10 new ideas to develop a trading edge in today’s markets:
1. Use More Powerful Software For Backtesting & Trading
It’s fair to say that trading software has improved a great deal over the last few years and those programs that fail to improve will be left behind.
Traditional backtesting programs and website services that attempt to do it all are likely to be displaced as traders learn to use more powerful and more accurate tools.
As I mentioned in a tweet recently, I’ve found that some of the low cost backtesting programs do a very poor job of testing rules and presenting accurate results. They may have been OK for 1980s markets but time has moved on.
There is also a proliferation of open source software. This software is free and surely powerful but it often comes with a large time investment. Sometimes if you want to develop a trading edge, it’s better to pay extra to get the tools that you need.
2. Utilise Alternative Data Sources
I have spoken of alternative data sources before but they are growing in popularity among hedge funds and traders. Some examples of alternative data might be:
- Satellite imagery of shopping mall car parks to guage consumer spending
- Satellite imagery of gas holders to guage supply and demand of natural gas
- Customer receipt data to guage company sales
- Investor sentiment data to guage appetite for a stock
- Google search data
- Simply using any non-price data to find new trading ideas
As you can imagine, there is no shortage of ways to use alternative data.
According to a study by AlternativeData.org, over 150 hedge funds and money managers employ at least 340 full time data analysts, scientists and engineers.
Therefore, if you are not utilising alternative data sources you may already be behind the curve.
3. Central Bank or Government Intervention
If you want to be on the right side of the market, one option is to follow the money being spent by big government institutions and central banks.
One of the clearest examples I can think of is the Bank of Japan which has been buying up Japanese Government Bonds (JGBs), gold, corporate bonds and even equity ETFs in vast quantities since 2013.
It has now begun to taper some of those purchases but there is no doubt that the BOJ is still there providing significant support on the buy side of certain markets like JGBs and the Nikkei. In hindsight, it’s no wonder these markets have rallied with such underlying support.
This kind of market bias can give an extra layer of confidence to long based strategies.
4. Web Scraping
One idea I have been thinking of lately is using web scraping tools to gather financial data for analysis that is not simply price data.
For example, what if you could build up a daily historical database of prices, fundamental ratios, sentiment scores, even news stories or headlines and use that data to develop a scoring system for the selection of stocks?
Most quants are still focussed only on price data so this is a route that could be fruitful. If you have the skills to create such a thing then please let me know!
5. Artificial Intelligence
Carrying on from the last point, what if you could take the data you gathered and use artificial intelligence to learn new trading rules as the data comes in.
Similar to the way the AlphaGo robot was able to master the ancient game of Go with neural networks, artificial intelligence on various data sources could lead to new trading strategies that no human has ever thought of before.
Something like Genotick, which I discovered recently, might offer some inroads into this vast chasm of opportunity.
6. New Arbitrage Opportunities
Arbitrage concerns the ability to make a risk-free profit from buying and selling what is essentially the same security but at different prices.
For example, if Apple stock is offered on one exchange at a price of 125.00 and is available to sell on another exchange at 126.00, you can buy at 125 and sell at 126, locking in an instantaneous profit that is virtually risk free.
Of course, arbitrage opportunities are hard to find in today’s efficient markets and they may require superior technology as well.
However, there are also more markets to trade than ever before. I read on the FT recently that there are around 70 times more stock indices than there are quoted stocks. This proliferation of ETFs, indices, and derivatives mean that arbitrage opportunities might be a profitable avenue to pursue for those looking to develop a trading edge.
7. Inefficiencies in ETFs
As mentioned above, there has been an explosion in ETFs in recent years, including leveraged ETFs, and these are opening doors to new trading opportunities.
In fact, two of our most recent trading strategies are designed to trade such leveraged products.
The majority of ETFs disclose their holdings on a daily basis, and if an index changes in value the ETF must adjust its holdings before the close of the day.
Some regulators are concerned that hedge funds and HFT firms are taking advantage of index changes to front run the ETFs into the close.
Perhaps inefficiencies like these exist for the retail trader to exploit too. Can you recognise price patterns going into the close of certain ETFs?
8. Reading More
Maybe the way to get an edge in today’s market is not to look specifically for new strategies but instead, to simply take in more information.
In the past, traders have had to rely only on Bloomberg and papers like the Wall Street Journal to get their news which by extension means most traders are looking at the same things.
But the internet gives everybody a voice and it’s possible that just reading and absorbing broadly can provide new trading ideas to take advantage of on a regular basis. Areas like small cap stocks where the big players can’t play are ripe for this.
Journalling and keeping track of your trade ideas can be a way to quantify this type of approach so you’re not simply trading blind.
9. New Market Regimes
As we enter new market regimes, previous winning trading strategies will start to falter and new trading edges are likely to be found.
The big example that comes to mind are US Treasuries which are now in a bear market according to legendary bond trader Bill Gross.
US treasuries have been in a bull market for the last 37 years and most long strategies have been profitable during that time. If the up trend is over, short strategies will come back in vogue and begin to do well instead.
In fact, a simple short strategy for the US ten year that I wrote about last August has continued to be profitable since I shared it on this blog:
10. Emerging Markets
As technology and liquidity improves it will become ever easier to trade new emerging markets.
With access to historical data and more useful research these markets will no longer be reserved for boutique hedge funds but will be available for retail traders too.
Given the less developed nature of some of these markets, they are likely to be less efficient and therefore offer greater rewards (and risks).
Nowadays, you can already get historical stock data from countries like China, India, Ecuador, Poland etc. One such source is Quandl.
Cryptocurrencies are also offering new opportunities to traders and the future of financial technology (fintech) means that we should see even more new ventures in the future.
Thank You For Reading
Joe Marwood is an independent trader and the founder of Decoding Markets. He worked as a professional futures trader and has a passion for investing and building mechanical trading strategies. If you are interested in more quantitative trading strategies, investing ideas and tutorials make sure to check out our program Marwood Research.
This post expresses the opinions of the writer and is for information or entertainment purposes only. It is not a recommendation or personalised investment advice. Joe Marwood is not a registered financial advisor or certified analyst. The reader agrees to assume all risk resulting from the application of any of the information provided. Past performance, historical or simulated results are not a reliable indicator of future returns and may not account for real world settings. Financial trading is full of risk and margin trading can lead to financial losses totalling more than what is in your investment account. We take care to present accurate analysis but mistakes in backtesting and presenting of analysis regularly occur. Please read the Full disclaimer.
Thank you to everyone who takes the time to leave a comment. Your feedback, constructive criticism and identification of mistakes is welcome. In order to concentrate on work I may not have time to respond to all comments.