If you want a market return or don’t think you can beat it, buy an index fund. Presumably you are here because you want to do better.

To beat the market, you have to have an edge: inside knowledge, faster access to information, uncovering trends early, or moving faster.

Insider trading is illegal, although judging by some stocks’ moves ahead of important announcements, still fairly wide spread.

The information advantage was effectively eliminated by the SEC’s Regulation FD. I suppose you can still get tipped off ahead of the crowd every now and then but I don’t see how you can make a living off it.

Uncovering trends early requires time, dedication, and intelligence. You have to stay on top of current trends, spend a lot of time doing independent research, be able to tell a trend from a fad, and draw your own conclusions while ignoring most pundits, gurus, and talking heads.

Moving faster than others seems to be the prevailing trend: faster execution, more sophisticated order entry systems, shorter time frames… If you can beat the crowd by 10 min., or a day, you win. Presumably.

When a growing crowd tries to exploit the same “edge” – in this case, the time element – the edge produces diminishing returns. Despite what they currently teach you in school, not everybody can be above average, not everybody can be a winner. The edge based on the time element, or faster execution, facilitates transfer of wealth, not its creation. And like it or not, it’s a transfer from the many to the few.

In stock trading, a system stops working when too many people start using it. For example, “Dogs of the Dow” was the rage in the 90s. Why bother with anything else when you can outperform the Dow by investing in the 5 or 10 highest yielding Dow 30 stocks? What happened? Too many people jumped onto the bandwagon. All major brokerages were offering some version of the strategy. The result: every quarter, every month there was somebody rotating out of “winners” into new “dogs.” The system stopped working.

If you want to create an edge for yourself, you have to find a less crowded route. You simply cannot outsmart everybody by doing what everybody else is doing.

Today, we all get the same information more or less at the same time. So it’s not the information that gives you the edge (nor how fast you can use it), it’s what you do with it. That requires a fair amount of intelligence, time and dedication. But you also need a system.

It would seem that betting against the crowd, not with it, will give you that edge. It does not necessarily mean selling when everyone is buying, and vice versa. Example: Many trading systems used to coach to never lose more than 10% on a trade. When a lot of people started following that rule, a stock declining 10% would trigger an avalanche of stop sell orders, causing further decline. So somebody figured that if they place their stop at 7 or 8%, they will get out ahead of the crowd. Eventually, more and more people moved to the 7-8% threshold. Now, if a stock declines 7 or 8%, it triggers an avalanche of stop sells, causing a further decline, but rarely of more than 10%. As a result, you get stopped out at 8% only to see your stock come right back up. The solution?

Move the stop back to 10% to avoid the stampede from below. Chances are, it will never get triggered, and you will never get whipsawed by accepting a little more fluctuation. So, if everyone is trading off an intraday, 3-day or 10-day chart, it makes sense to use a different timeframe. You may have to live with more fluctuation, but you will also be betting against the crowd, not with it. An advance from a breakout usually lasts anywhere from several weeks to several months. No need to watch your stock(s) intraday as long as you have protective stops in place. Trading on price and volume is the oldest trick in the book that goes beyond the scope of this article. But the majority of new stock “traders” seem to prefer faster clicking to studying Livermore’s or O’Neill’s time-tested methods.

Slav Fedorov is a full time stock trader and founder and managing member of TradingZoom, LLC – a provider of timely stock picks in small caps based on proprietary selection methods. http://www.tradingzoom.com/

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