Can Massive Use Eliminate Profitability ? - Looking at How Crowds Affect EA Performance

One of the most important reasons people have to believe that long term profitable trading using automated trading systems is impossible is that the simple appearence of a consistent and profitable system would most likely cause mass adaptation of the strategy, something which would render the inefficiency exploited by the system totally worthless. This is a very interesting issue and there are actually several explanations and examples to show you that long term automated trading is possible and that mass adaptation is actually not likely to happen in most cases and that when it is likely to happen, the system is indeed bound to become unprofitable. On today's post I will talk about this issue of "mass use", its consequences, the reasons why it happens and the reasons why it won't happen to most long term profitable systems.

It is easy to imagine that if any system was able to produce massive riches in a consistent manner, in a short amount of time, everyone would like to get "a piece of the action" trading this strategy. When many people start to trade the same strategy you get a great increase in volume around certain price levels around predictable price action. Since the strategy is widely available, anyone could look at it and figure out when it is bound to enter or exit trades (even if it is only a signal service one could infere these from context). When people start to see what the strategy attempts to do, proffesional traders will exploit the inefficiency created by the movement caused by the system. Since the system is predictable by the market now, traders attempt to exploit the movements caused by the exit/entry of positions caused by the system's signals. This in turn leads to an increase in losing positions for the strategy since the money won by the traders exploiting the "new inefficiency" is taken from the money invested by the users of the initial system.

The main consequence of a system being massively adapted is that its use generates an inefficiency that is exploitable by other traders due to its predictable character. This in turn leads to higher draw down levels and an increase in the number of consecutive loses. People will start to quit trading the strategy when this happens and the strategy will probably regain some of its profitability once the draw down of the strategy is increased enough as to diminish its trading volume significantly (to pre-"mass adaptation" levels).

If you see, it is a sort of self-regulating phenomena. A system with extremely profitable results appears, mass adaptation follows, incredible increase in draw down characteristics happens, people lose interest, the system then regains profitability (although it is now much less "attractive" due to its increased draw down characteristics). However, some systems are much more vulnerable at going through these cycles while others may have a "natural defense" against this from happening.
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As you may know, the Turtle Trading system has been profitable since the start of the 80s and - at the beginning - it was massively adapted to a certain extent due to the huge success the turtles had when they caught massive commodity trends in the beginning of this decade. However it soon became evident that the strategy had some characteristics that discouraged mass use. For example, long term profit targets turned out to be much lower than those initially achieved and the system demanded a lot of patience and effort since long 3-4 year draw down periods amongst individual instruments were possible. This in turn led to a massive discouragement that has kept this system long term profitable up to date. This is a true and living example of the above explained phenomena that clearly shows the market's adaptation to strategies at its best.

However there are other types of systems that are in particular danger when you look at this perspective. For example, systems like Martingales and Scalpers which take small and steady wins based on a very bad - sometimes even uncapped - market exposure, tend to grant long periods of profitable trades followed by sharp yet decisive periods of draw down that usually end up in wipeouts. It is very common for these systems to be unable to withstand even a two or three position increase in their maximum number of consecutive loses. If mass adaptation happens and draw down characteristics are bound to be increased then a simple moderate increase is bound to wipeout most traders using these systems. However it is possible that the market will just cause an increase large enough to discourage/wipe most traders while the most conservative ones will be able to survive at profit/draw down levels equal to those of more conventional swing/trend following systems. Interestingly, mass adaptation is another way in which the market controls average compounded yearly profit to maximum draw down ratios.

The systems I use are made to fit into the first group, where the regular trading characteristics of the systems already discourage mass usage since the profit targets, draw down levels and expected periods of draw down are already very hard to endure for most traders. The key is that mass use is discouraged through the regular draw down cycles of the strategy and therefore the chance of a market correction due to mass adaptation is mostly eliminated since the strategy won't need an increase of its current draw down characteristics to reduce mass adaptation. However my conclusions are just based on observations of what has happened to previous systems and how their characteristics have evolved or remained constant over time, definitely it will be interesting to see how Asirikuy systems evolve and how effective they will be at discouraging mass usage through their regular draw down characteristics.

If you would like to learn more about my journey in automated trading and how you to can learn to design and use your own likely long term profitable systems please consider buying my ebook on automated trading or joining Asirikuy to receive all ebook purchase benefits, weekly updates, check the live accounts I am running with several expert advisors and get in the road towards long term success in the forex market using automated trading systems. I hope you enjoyed the article !