Why stock trading systems fail

Why trading systems stop working and how to invest to win

A few of my friends were day traders in the heady days before 2007. They would be at home trading stocks all day in their schedule C defined the home office. This was often to their wife’s irritation. Or these day traders would at least be online checking quotes at their day job making, with their figure close to the anti-boss key on their keyboard, that would minimize the charts and graphs in a second as she approached.

They were making much more money in the market than their 3% annual increase and a pat on the back could ever do for them.  All of these traders now are clinging to their brick and mortar cubical jobs now.

Trading systems often work for a while. You fall in love with them, chat with your friends about the trade details, like two pregnant women at the hairdresser. Then one day they stop working and you lose money. They cheat and betray you. You are emotionally married to the system so you cannot believe it is failing. You lose more money and eventually you realize the truth it is not working. You want to give up on trading (relationships) altogether. But hope wins over experience and you find yourself back in the saddle again. The purpose of this post is to look at why systems fail, some examples of famous stock trading strategies that stopped working and what the alternative is.

Here are three possible reasons they stop giving you an above-average ROI:

  • Information becomes too perfect – The information becomes too widespread and the information becomes perfect and the system goes back to normal economic profits.
  • Systems do not work, – but they are rather perchance ‘winning streaks’, which like empires, have their end.
  • Markets evolve -The world of money and trading changes and as the world develops so systems need to evolve or go the way of the dinosaurs. This is similar to chess. The masters of the 19th century would be no match for the champions of today. The game is the same but the approach is different. This is significant as the market like chess always involves other people. It is not a closed system but socially interactive. Like in chess, it is not just what white does but what black does too.
  • Exogenous variable changes -Some major variable outside the systems calculated equations start to exert a strong influence on the world of money and markets creates a shift. Previously it had no influence on the system or did not exist. Similar to the above point but more cataclysmic like a global political event or an unexpected shift in technology. A metaphoric, monetary asteroid hitting the planet and the cosmic dust cloud changes the environment.
stock trading system to beat Wall Street
New York Stock Exchange -Wall Street. If you want to beat the street choose your stock trading system carefully.

Four examples of trading systems that stopped working

Turtle traders – Richard Dennis knows as the ‘prince of the pits’ had a bet with a friend that he could train people to trade and get rich. He won. His team of turtles made 124 million dollars. He subsequently started Turtle trading training. When I was a stock broker, a friend of mine was trying to talk me into doing the course for like 10,000 dollars. I am glad I did not. Why? The trading system stopped working.

It worked in the 1980s and up to 1996. Then it stopped. Some people have made a derivative of this system and still use it today but the core system of using stops and exits and tends does not work. This is a case study in itself.

Reason profits stopped: I think technology changed and people started to trade with software. It changed the equation.

Dogs of the Dow – A basic value or contrary play. Dow stocks have stood the test of time and often are down but not out. If you identify the top ten dividend-yielding stock (a sign of value as the price is down in relation to the dividend payout) then you will get better than average returns in a safe way. You can also do this for the top five. Find the second-lowest price stock (The lowest price might be low for a reason and stands a chance of slipping off the Dow list, and that is not good for anyone) of the top ten dividend-yielding stocks will give you than the even better return on your investment.

Hold these chosen dogs for a year and this will give you a good return on investment. Use leverage even better. This investment strategy worked even in bear years. I think the world is no longer centered on GM type stocks. Therefore, Markets change and your strategy have to.

Then it stopped working and the losses canceled out gains. It is still conservative but not the best way to invest.

Reason profits stopped: Markets changed and GM type stocks are no longer the nexus of the universe, which the world revolved around.

Motley fools portfolio system – They had a system and it worked for a while then stopped or did not stand up to the rigorous of testing in the long-term. They made money-making their name, and not accumulating capital. They are still a good provider of information.

Reason profits stopped: I think this system never really worked in the first place and they made more money on selling financial information, maybe not.

Brokerage firms analyst picks – When I use to work at Merrill Lynch we had focus stocks. These did well for a while. They were the analyst’s top picks. But only if you bought and sold the second and I mean the second, with no transaction costs a stock was added or subtracted to the list.

The reason you could not make as much: Needs to work in ideal conditions and hold the whole portfolio with special pre-news prices on the trade.

How to build your own stock trading systems that work

Therefore, systems stop working or never really worked in the first place. Build your house on stone and not sand.

This is why I recommend finding a quantitative investment firm that has long-term results like 20 years plus, rather than a simple model. Investment information that is back tested and uses academic or scientific rigorous of testing. I do not care about brand name investment houses.

To develop your system read a lot of investing books for ideas and use a quantitative investment screen.

These can be free or paid for a nominal charge. Not some high-priced firm or system that does well over selected years. But give ROI information over the range it does well and under some ideal situation. But real honest science. Not some guy hoping to make money on selling his system. If some guy does this, ask yourself why are they not spending time making millions in the stock market and not selling you something for $149 a pop.

Me, I do not claim to be a Wizard of Wall Street nor do I sell anything. I am just conveying my experiences over the years of investing. And I have done well and now do not need a job. I will continue to develop my trading methods and one of these days maybe publish my results and let the facts stand for themselves. But before looking to me, I more encourage developing your own system for stock trading.

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4 responses to “Why stock trading systems fail”

  1. Erik

    Mark interesting post and look at trading systems. I think you make a good point, why is someone spending their time hawking a stock-picking program rather than applying it and making money in the markets?

    However in your opinion are there any stock strategies that have perhaps stood the test of time better than others? What kind of advice would you give someone with $10,000 to invest in a portfolio?

    1. Mark Biernat

      Great question, I think I will write a post the best way to invest 10,000 and this will answer the question in more detail. Of course it will involve stock trading.

  2. Martin

    Really enjoying reading through your posts. I found your site as I am currently reading Stan Weinstein’s book, and its the only book on technical analysis that has given me confidence technical analysis is actually based on sound thinking and simple rules that can be applied.

    My only critique of your site is that its a shame none of your posts have a timestamp on them. It would be useful to know when you’ve posted your thoughts. Other than that, great content.

    1. Mark Biernat

      Because of the simplicity of Weinstein’s ideas, people might dismiss it but in the context of Occam’s razor and personal experience, I think these are relevant technics for trading stocks. Timestamps are a consideration, admittedly I need to update the whole site.

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