Updated: May 8, 2021
The key variables used to define opportunity cost are the traded time frame, the frequency of plays, and the size of the playbook. Every trader has the same time window to squeeze the opportunities out of the market. Still, every trader has a different set of patterns they trade, different trading time frames (some trade high time frames such as hourly, and some low time frames such as minute, intraday), and every trader can input different hours into watching markets every day (some are full time traders and some are part time). This all creates a vast area of opportunity costs that arise from those differences.
To sum it up, the opportunity cost in trading is created by:
-traded time frame
-full-time trading or part-time (the amount of time/hours that trader can input into trading each day)
-frequency of play
-number of markets traded
-random chance of pattern appearance at that month (some months have higher spawn rate, some smaller)
-efficiency of traders watch-listing and asset tracking through the day
-depth of playbook (number of traded setups that trader has the edge on)
The lower the capital, the higher the opportunity cost. The lower the leverage/margin, the higher the opportunity cost. With less capital, usually trader is restricted to trade only cheaper assets and since commission cost impact will be higher trade will have to pass on specific opportunities in markets where the commissions are higher. Smaller capital also prevents trader from swinging many positions at once, which could be problematic for those who excel more at swing trading multiple assets at same time.
The higher the time frame traded, the higher the opportunity cost. On higher time frames it takes more time for a specific pattern to emerge or complete, and the factor is by default increasing exponentially the higher the time frame selected. For example, a 1-minute intraday chart might provide ten times as many opportunities as an hourly chart.
The lower the frequency of traded pattern, the higher the opportunity cost. If the pattern is very infrequent trader will have to wait a long time before such pattern re-emerges. Ideally, patterns should be as frequent as possible in order to give traders more opportunities to smoothen the growth curve and let the edge come through as a large sample base of play, rather than a smaller sample base.
The fewer markets tracked and traded, the higher the opportunity cost. Each market only gives a limited amount of opportunities every week. The more markets that one trades, the more opportunities will be packed within each week.
The weaker the efficiency of multitasking and tracking of markets, the higher the opportunity cost. The more positions that traders can handle having opened at the same time, the lower the opportunity cost will be, which will depend on the multitasking capacity levels and skills.
The smaller the depth of the playbook, the higher the opportunity cost. The more patterns the trader has researched and has edge-on, the more potential opportunities he/she has to extract value from.
To put it into a simpler equation, ideally, a trader should be striving to trade with more capital rather than less, trade as low time frames as possibly one can handle, trading high-frequency patterns (those present every day), trade several markets instead of just one to always focus on where the best opportunities are, working on multitasking skills to perform better at handling many positions at once and work constantly on increasing the size of the playbook. The opportunity cost will be minimized with such an approach.
What creates opportunity costs in most cases? High time frames and low-frequency patterns or non-liquid markets. This is one of the major reasons why traders prioritize low TFs (time frames) much higher over high TFs because capital can be quickly free in short-term plays, and the pattern will re-emerge on lower time frames quicker to be played again.
If 1 minute and hourly chart play both set up simultaneously, which one should be taken with priority? It should be 1 minute play because that one will be resolved in a much quicker time, perhaps even allowing traders to afterward engage in hourly play. It should be pointed out that commissions and spreads add significant obstacles in making low TFs trading harder and edge thinner, but for the sake of this article, this is not the priority focus, this is subject for another article.
In general, the whole industry is positioned backward, especially towards beginners, and misinformation spreads around. "Trade high time frames only, due to X and X factor present on low time frames" is what is often preached to most beginners. But what many fail to mention is that low frequency of opportunities give low amount of P/L reward unless one weigh those opportunities with heavy position size (which should be avoided).
Practical ways to decrease the opportunity cost in trading
There are many ways to approach this problem, I will list some of the actual solutions which might not be fit for every trader. This is especially essential for anyone who wants to approach markets more seriously for somewhat consistent performance. Make those 5 rules your core skeleton structure no matter what market you trade, and your overall opportunity cost will drop, and alongside that are also positive consequences that come because of it.
1.Decrease trading time frame
If one is trading high time frames such as H1, H4, or Daily time frames, switching to lower time frames under M15 might be a way to go. By majority, traders will shape their trading based on their personality strengths, so by the second or third year of trading, most traders will essentially have their trading strategy shaped around their preferences and strengths. That is why many traders who are calm and careful action takers and like to take a lot of time for making decisions will usually be drawn to higher time frames, and the traders who enjoy more frantic and quicker trading will be guided towards lower time frames. There is a balance that one should strike, yes follow your strengths but try to go as low as you can on time frames to avoid too much opportunity cost. It is a balancing act.
2.Increase the size of playbook
Increasing the playbook size means that trader has to keep learning new markets, new patterns,and new plays. Then researching those and forming strategies around them. The more patterns that trader has in the playbook, the more executions can be made, and the more fluid the equity curve could be if the patterns and strategies around them have an edge. Again it is a balancing act because it takes time to adapt to each new traded pattern, and one does not want to over-load trading with too many patterns as it can become chaotic. This is not advice per se because it will hugely depend on how hungry trader is and how passionate to keep digging for new plays and expanding the playbook, not all traders are on the same level.
3.Increase the capital on specific traded account/market
Often small capital size can be costing traders the opportunity to take additional trades, especially if the market or broker has low leverage. Increasing capital can solve that problem, but that should not be taken easily. A trader should carefully weigh if there were really many opportunities that he/she missed a past month because capital was locked in the initial trade, and he/she was unable to execute additional trade due to that. If that is the case, it might be worth adding more capital. Practically for most traders, that will not be an issue, mainly this will only become an issue for seasoned traders who take many trades per day.
4. Increase trading efficiency, watch-listing, alerting, screen time
Some traders are better at multi-tasking, and some not as much, but no matter if one is good or not, anyone can improve their efficiency of how they actually track the markets and how they track and make their trades. For example, a trader could add more monitors to have an easier track of more traded assets, or if the trader is good at multitasking, simply just adding more software and use of alerts will do the same trick. As long as one knows where to place alerts for where the setup might take the development phase of confirmation, it can improve the efficiency in trading a lot and especially decrease the screen time of tracking. It can benefit any trader to implement into their trading routine, learn to use alerts along with your setups, and know where to place them so that you can take your eyes off the asset and place them somewhere else and decrease your opportunity cost.
Use hotkeys and specific indicators that can help you quickly calculate position size, SLs, targets, or similar things. This can have an impact on opportunity costs as it makes you a calmer trader and more organized. The majority of equity and futures trading software allows the use of hotkeys, and the majority of FX and futures allow the use of indicators for trade management. Crypto is lagging but getting there slowly.
Below is an example of alert use on equities (in the case of ticker ALT, there was interest for short entry around where the alert lines were set). Once the alert is set, a trader can move forward to some other asset. Anyone can try to use this method and shape it differently to fit it to personal preference to decrease opportunity costs in trading.
On MT4, using a similar alert system by right-clicking on the chart and setting an alert at the specific price ("set alert"). Same method used in crypto on Binance and Tradingview charts.
Optimizing the trading routine can significantly decrease opportunity cost because trader will have more spare time to hunt for market opportunities and a cooler and more collected mindset.
At the end, learning and experiencing new markets will allow traders to increase opportunities the most. It comes at the price of capital losses (losses from mistakes) and the highest price of it all, which is time. But that is at the end where the real opportunities grow, gotta put in the time and work to make the fruits grow. Or to use the words of Ed Mylett, to collect life's candy, you have to put a lot of work into it and stick to it, only those that stick to it for long enough get it. The trading industry is a great example of such a thing.