A trading edge describes the reason you are able to expect to experience positive returns through what might appear to be random trading. This generally equates to being able to take profits out of a market even after accounting for transaction costs and slippage.
While trading edges can be present in strategies designed for any market, having an edge is far more important when trading Forex markets. Stock trading strategies can produce profitable long-term returns even without an edge. That is simply not possible in the Forex markets.
Daniel Fernandez from Mechanical Forex wrote an interesting post about how fundamental bias affects Forex and stock trading. In that post, he explains why having an edge is so much more important in Forex trading.
Stock Trading Edge
Fernandez begins his post by explaining why having an edge isn’t a necessity when trading stocks:
The stock market in particular has a natural tendency to go up in the longer term because there is a net creation of wealth behind the companies represented within the stock exchange’s shares.
Because the stock market has a long-term upward bias, a stock trading strategy can completely lack an edge and still earn a profit because of the tendency of the stock market to increase over time. This means that any random long stock position is more likely to go up than down. Of course, that bias takes place over the long-term. Anything is possible in the short-term.
Forex Trading Edge
In what I found to be the most interesting part of the post, Fernandez compares a long-term chart of the S&P 500 to a long-term chart of the EUR/USD currency pair. While the S&P 500 has grown tremendously over the five years the chart represents, the EUR/USD has never ventured very far from the zero line.
Fernandez explains that because currency pairs trade based on their value relative to each other, there is no reason to believe that any pair will increase in value consistently over a long period of time. They don’t have the same fundamental bias that we find in stocks. This means that anyone trading Forex markets will absolutely have to have some sort of edge in order to consistently take profits out of those markets.
Why Trade Forex?
If Forex trading is naturally more difficult than stock trading, why would anyone choose to trade Forex markets?
After painting a very clear picture about how difficult Forex trading can be, Fernandez reminds us that there are also plenty of advantages to trading Forex. Some of the reasons he lists include low capital requirements, the ability to leverage capital, and the fact that Forex markets offer uncorrelated alternatives to equities. He points out that while trading Forex markets can be incredibly challenging, it can also be very rewarding.