It’s a lament I often hear about trading strategies: It was doing just fine, then suddenly it stopped working.
The conclusion many traders draw from this is that: The trading strategy must have been fundamentally flawed in the first place.
The truth is actually a lot simpler than that – it’s the law of ever-changing cycles.
Staying a step ahead: why you need another trading strategy
The principle of ever-changing cycles was first raised by horse-racing bettor Robert Bacon back in 1956, and since then has been much advocated by trader Victor Niederhoffer.
Here is what Bacon says:
There is no danger of the public ever finding any key to the secret of winning. The crazy gambling urge and speculative hysteria that overcomes most players at the track makes that fact a certainty. But, if the public play ever did get wise to the facts of life, the principle of ever-changing cycles of results would move the form away from the public immediately.
The principle of ever-changing trends works to force quick and drastic changes of results sequences when the public happens to get wise to a winning idea.
What Bacon is saying is that, just as we begin to enjoy a winning “edge” – we can expect cycles to change, and that edge will disappear.
These ever-changing cycles are around us everywhere…
The fashions that people stop wearing “because everyone’s wearing it now”.
The bar that we don’t go to anymore “because it’s just too crowded”.
The stock that we wouldn’t consider “because that story is over”.
Sometimes these cycles are self-perpetuating (i.e. a trade becomes too popular, and the market corrects itself), sometimes it’s caused by external factors, like a long-term trending market becomes range-bound.
Either way, as traders, we can’t control the markets – we can only respond to them.
How to evolve with the markets
This may sound daunting to us traders, who simply want a quick and easy strategy that we can apply again and again.
I don’t particularly want to learn new tricks, and just as I’ve mastered them, to have the rug pulled from under my feet.
Fortunately, cycles don’t have to be that complicated.
I recently read this story, which perfectly illustrates just how simple cycles can be…
I work at a four-story building. The trading floor where I work is on the fourth floor. The traders are very messy guys, and you can’t imagine how filthy the toilets are on our floor. The second floor, however, where the operations department is, is a female-dominated environment where the men’s washrooms are totally unused and spotlessly clean.
I discovered this fact the day I started working here five years ago. I started visiting the washrooms on the second (the clean ones). I would take the stairs to avoid being asked in the elevator what I was doing on the second floor.
A few months ago, I found out that our operation is moving to one of the towers downtown. I figured what the hell, I’ll take the elevators. Even if they ask me where I am going, I’ll tell them. By the time they catch on, we’ll have moved downtown.
Sure enough, I was asked in the elevator what I was doing on the second floor. To my surprise, in less than a week everybody was going to the second-floor washrooms. Now the second-floor washrooms are the messiest of all, and the fourth-floor washrooms are clean again. Saves me the trip.
We can learn a few important lessons from this story:
– If we have an edge – we shouldn’t share it with too many people.
– Cycles will change, and will often change faster than you’d expect.
And the last point is perhaps the most important and surprising one.
– Once your “edge” becomes public knowledge, you may be surprised at how little you need to change your behaviour in order to find a new edge.
Changing cycles don’t mean that we have to throw out our methods and start afresh – they simply mean that we need to keep nimble and adaptable.
The answer to “fixing” a system that’s stopped working is often a lot closer than you think.
Two keys to building a trading style that can change and grow
While past behaviour has never been a very reliable indicator of how the markets are going to behave – I’m afraid, it’s all we’ve got to go on.
And if past behaviour can teach us anything – it’s that market behaviour changes.
Long-term bull runs become long-term bear runs… range-bound prices suddenly breakout…
And if we want to survive and thrive as traders – we’ll need to take these changes in our stride.
The two factors that I believe can help you here are:
1. Look at the big picture of the market. Is your trading strategy suited to this type of market? Are you using a range-bound strategy in a trending market – or vice versa. Yes, you may need different strategies for different market conditions – or you may just need to tweak your timeframes. (Check out my post “How to choose the right trading strategy” for more tips on matching your strategy to market conditions.)
2. Improve your entry. Over the past month I have been looking at what constitutes a successful trading strategy, and the pieces of the jigsaw are: the set-up, the entry and the exit. Too often traders will throw out an entire trading strategy, when all that’s required is a bit of fine-tuning on the entry level.
So, back to the nitty-gritty – do we need to change our strategies?
Yes – trading strategies need to move and adapt to the markets. But that doesn’t necessarily mean that you need to start afresh with a completely new strategy, provided you’re willing to put the time and effort into a little adaptation.
If you have a strategy that is flexible enough to adapt – great. If you look at the off-the-shelf systems out there, the ones that keep on going, bringing in profits, are the ones that have this flexibility.