System Shelf Life/Discovered systems

[Sharkfin]

Numerous publications talk about the concept of a system ceasing to be profitable simply because it becomes too well known. The theory goes that a profitable system, once discovered by every other trader, will quickly become unprofitable. I am fairly new to system development and I wondered if anyone could shed some light on the reasons why this occurs. Not why people discover systems (that's clear) but how their discovery makes systems unworkable. All the literature I've consulted on this point talks in vague terms e.g. "everyone sees it coming and spoils it for everyone else" or "with so much money taking up the position, the inefficiency is lost" or "the smart money fades the position". If we take a simple system based on long trades on the formation of triangles (let's assume there is a positive expectancy), how does everyone's recognition of a triangle distort the position? If everyone sees the triangle and everyone wants to go long then how has the position become spoilt? Similarly, how do I or how do we (as a market) hope to fade buyers of the triangle? What I was most interested in, in reading the literature, was Alan Farley's "The Master Swing Trader". He talked with much humour of how he sees a pattern developing and waits for all the longs (like lambs to the slaughter) take up a position (i.e. price goes north) before he then fades the position. How does he do that? I could understand fading a position where it's clear buyers have started to lose the initiative but otherwise? Farley says that in the modern era where everyone has whizzbang technology and every Jimmy Trader can spot a basic pattern, small traders' equity is hit hard. Can anyone educate me here to the specific dynamics/market psychology at work? Please reply on the point.
Best of luck to you all for the coming financial year.

 

[barjon]

sharkfin

Imagine you are a large player with a big position to sell. You want to get the best price you can. If you just dump them on the market the price will collapse since you'll frighten off all the buyers and sellers will add their holdings to yours. So you work the market - sell some, buy some back to encourage buyers, sell some more, buy some back and so on. Your objective is to keep buyers coming until you've disposed of your position.

Now picture this in your triangle example. Where are the buyers? They are sitting above the market waiting for the break north. So you buy, causing the price to move up and when it breaks north there are likely to be loads of little buyers clamouring to buy your shares enabling you to dispose of your position entirely (you hope).

jon

 

[TheBramble]

Numerous publications talk about the concept of a system ceasing to be profitable simply because it becomes too well known. The theory goes that a profitable system, once discovered by every other trader, will quickly become unprofitable.

Notwithstanding that very precise explanation of how the theory might work given by barjon above, there is another factor - or two.

No system would ever become SO well known that ALL traders would use it and trade it flat. Look at Fibs, Pivots, S&R. Basic stuff. EVERYONE knows about this and to some extent may be self-fulfilling. But it STILL exists. It hasn't been traded flat. Why? Because not ALL traders will ever do EVERYTHING the same. Some traders wont ever look at these setups/conditions - others trade nothing else. Some will trade them for a while and them move on to the latest 'thing'. Just post a chart of any instrument ans ask people to PM you with where they assess the highs and lows for their Fib calcs. You'll get more different answers/levels than the same. No group of any size in any endeavour will EVER ALL do the SAME thing in the same circumstances, every time those circumstances occur.

The other factor is that it isn't system which trade systems flat - it's changing market dynamics which render them so. Now and again.

So you go right ahead and develop your systems. Good ones that work. And continue researching and developing them to suit the changing markets.

 

[Tuffty]

If the market price is 100, and every one knows a system that says buy at 101 as it'll go to 110. Everyone is a buyer at 101 so what will happen is the market will go straight past 101 with very few orders filled as the buyers outweigh the sellers untill a price level is found where the buyers and sellers are more evenly matched, say 109 for example.

 

[Tuffty]

No group of any size in any endeavour will EVER ALL do the SAME thing in the same circumstances

One could argue that financial bubbles and crashes are the nearest to the above. Hopefully we will be the ones doing something different.

 

[barjon]

Notwithstanding that very precise explanation of how the theory might work given by barjon above, there is another factor - or two.

No system would ever become SO well known that ALL traders would use it and trade it flat. Look at Fibs, Pivots, S&R. Basic stuff. EVERYONE knows about this and to some extent may be self-fulfilling. But it STILL exists. It hasn't been traded flat. Why? Because not ALL traders will ever do EVERYTHING the same. Some traders wont ever look at these setups/conditions - others trade nothing else. Some will trade them for a while and them move on to the latest 'thing'. Just post a chart of any instrument ans ask people to PM you with where they assess the highs and lows for their Fib calcs. You'll get more different answers/levels than the same. No group of any size in any endeavour will EVER ALL do the SAME thing in the same circumstances, every time those circumstances occur.

The other factor is that it isn't system which trade systems flat - it's changing market dynamics which render them so. Now and again.

So you go right ahead and develop your systems. Good ones that work. And continue researching and developing them to suit the changing markets.

Absolutely, tony - objectives differ, interpretation differs, responsive action differs and if there was no differing there would be no market.

To the extent that various TA patterns accurately depict supply and demand (selling and buying pressure if you prefer ) they also depict where buyers/sellers may be clustered. Anyone in a position to work the market can take advantage of that knowledge. That doesn't mean it's always happening or that it always succeeds - it just means that there's the possibility.

good trading

jon