I have recently finished reading Way of the Turtle by Curtis Faith, a pretty good read. However, its probably a little out of my league given there is a good chance - based on the position sizing he states in his book - that i am well and truly under capitalised if i were to emulate some of the strategies adopted in the book. So i will put it down to an entertaining read, for now.
There were a quite a few of interesting things I read about in his book and one of which has sparked some additional interest from me. And I thought I would share this topic with some of you. Its on the topic of the “trader effect”. I have tried to search for this trading phenomenon on the net and on this forum , as well as others, but couldn’t really find anything of great depth. The closest i came was on the thread below. I have attached 2 of the more interesting posts on this topic. One from Nick Radge who gives a thorough run down of what it is and the other from Markrmau, who gives a good analogy for some of the beginners who may not fully grasp all the aspects of trading just yet (me included).
Curtis Faith describes the “trader effect” in his book as :
“....The fact that a particular method has made a lot of money in the recent past increases the likelihood that other traders would have noticed it and will start using similar ideas, increasing the chances that the method will not work as well as it did initially...”
He goes on to say “....An observer effect is a concept from physics in which the act of measuring a phenomenon affects the phenomenon; the observer affects the experiment by the act of observing. A similar thing happens in trading: The act of the trading can change the underlying market conditions on which the success of the trade is predicated. I call the this the trader effect. Anything that repeats with enough consistency is likely to be noticed by several market participants. Similarly, a strategy that has worked particularly well in the past is likely to be noticed by many traders, however if too many traders start to try to take advantage of that particular strategy, that strategy will cease working as it did previously....”
If this holds true with all trading systems, indicators, well known methods etc, then this gives me some concern.
Hypothetically speaking , lets say I have designed, back tested, in sample / out sample date, forward tested, MC analysed, and optimised what i think is a very robust and dynamics system. It has all the hallmarks of a great system and I it will be very hard for me to gain any more confidence before going live it it. Because it a positive expectancy, a good pfactor, CAR%, MaxDD, win% , etc. Its a long system designed for up trending markets etc, and my rules are simply ‘to follow the rules’, on entry, exit, position size, money management etc.
The problem arise here: say i hit a period of significant drawdown. (fine most would say ‘just keep going if you have a positive expectancy’) only now you have exceeded your maxDD (20% based on 10 years backtested data using MC analysis) and you are now reaching 30%. You’re consecutive losses are now greater than the max in your testing (12), you are currently at 15. Max drawdown so far is $28,000 (backtest showed a max of 20K)
WHAT WOULD YOU DO????
I read many posing this question on threads with varying answers. And the majority I have observed would say keep going (which is where my thinking would have been). But i after giving more thought to the trader effect, i am now not as confident that could continue trading during a new maximiumDD. What if the market has truly cotton to my macd crossover coupled with rsi and Bollinger bands (or whatever it is). Doesn’t that mean that all those popular indicators are now arguably obsolete and new traders like me should use them because they provide a false sense of security?
What about people writing books, selling trading packages, and running courses on established trading systems? By the very existence of this phenomenon, arent they are diluting their own profits by selling their system? or maybe their system used to work but now the profits aren’t as great so they realise they can make more money selling a ‘proven system’?
So my question is what are peoples thoughts on the 'trader effect', does it really exist? How long does each indicator or system last before people cotton on destroy?
In the above example would you continue trading in that maxDD phase of your trading??
look forward to hearing yoru thoughts