What You Trade Is As Important As How You Trade

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Happy 2021 to colleagues and readers. In this new year, I'll be doing something different with my blog posts and making efforts to link to the work of trading educators and mentors whose work I enjoy and respect. The goal is to highlight valuable lessons for traders and also to introduce ideas and contributors readers might not be familiar with.

This week's lesson is "what you trade is as important as how you trade." Here's a straightforward example from my recent coaching experience:

A trader focused day to day on "catalyst" events that would provide directional opportunity. For instance, he might trade breaking news from a central bank meeting, a data release, or a news headline. He worked diligently on refining his entries and exits in these trades, hoping to generate quick profits that supplemented his longer-term, thematic macro trades. Indeed, this focus on how he traded catalysts improved the Sharpe ratio of those trades over time.

During one of our meetings, he briefly noted some frustration that some of the catalyst trades went on to become great trending moves, but only after he had exited his positions. So, we investigated his recent successful trades and examined which ones went on to become larger opportunities.

What we found was that it wasn't just the move in a single trading instrument in response to the catalyst that made a difference; it was the move across multiple, related instruments.

A simple example would be a stock that moves higher on an earnings beat. If the move is idiosyncratic -- limited to that stock -- it tended to make for a good short-term trading opportunity. If the relevant sector moved higher on the earnings beat, this was a sign that the news signaled a broader opportunity for an entire industry and would be more likely to be picked up by equity investors.

On those occasions, it made sense to keep a portion of the position on, as long/short investors and trend followers were likely to join the bandwagon.

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