[pjethwani]

Hi Dave,

kudos on this excellent endeavour...

I had some rather philosophical questions for you

(i do apologise for bundling so many (related) questions into one thread)

say someone came up with this excellent trading system which could beat the market time and time again and all that jazz

... and they made this system public - so every body starts using it ..

what will happen then? will this reduce the effectiveness of the system over time?

A related question would be - as they say that for someone to win, someone else has to loose? is this actually true? can't everybody's wealth grow as the economy grows? (of course, provided they invest in the right companies, that grow with the expanding economy)

Is it that for Warren Buffet to become a billionaire, lots of people would have lost terribly in the stock markets?

please comment

thank you

- Paras

[David Waring]

Hi Paras,

Thanks for the questions and for the compliment I am glad you like the site.

say someone came up with this excellent trading system which could beat the market time and time again and all that jazz

... and they made this system public - so every body starts using it ..

what will happen then? will this reduce the effectiveness of the system over time?

Yes, this will reduce the effectiveness of the system for two reasons.

1. As more and more people jump on the bandwagon so to speak the size of the trades that this will create when everyone trades the system at the same time will start to move the market at some point. As this gets bigger it will move the market more and more until eventually the system will no longer be relevant.

2. If everyone knows about the system then there are going to be people who try to manipulate the market and profit by trading against the system. As an example lets say that this system recommends to buy Google at $600 with a stop at $575, market currently trading at $590 just as an example.

So if I am a big player in the market and I know that if GOOG hits $600 a bunch of people are going to buy and then put a stop in at $575, then I can wait until GOOG hits $600 and everyone jumps in and then I can short with a larger position. If the position is big enough it will drop the price down to the $575 level at which point all those stop orders will be hit, which will drive the market lower and I will make a bunch of money.

This is why in general the larger a hedge or mutual fund is the harder time that have beating the market. The greater the size in the market the harder it is to maneuver.

A related question would be - as they say that for someone to win, someone else has to loose? is this actually true? can't everybody's wealth grow as the economy grows? (of course, provided they invest in the right companies, that grow with the expanding economy)

Is it that for Warren Buffet to become a billionaire, lots of people would have lost terribly in the stock markets?

This is something that you read a lot but is not actually true. To understand why think about it this way. When a company issues their shares through an initial public offering (IPO) and the public buys them, although people may feel that the price is going to drop and go short the shares, this is not necessary. You could have an IPO where you had the buyers of the shares, the company selling them, and no short sellers. Now technically if the price goes way up from the initial offering price the company who issued the shares has lost out on the chance to make that additional money but they have not lost money in the sense that they are short their own shares.

Similarly, after the IPO, when you buy stock you may be buying from someone who is selling short (in which case if you make money they will lose). More than likely however you are buying that stock from someone else who bought the stock before you and is now selling (in which case although that person may "lose out" on the opportunity to make money if you do they have not lost any of their money.

Hope that helps. If there are any other questions or comments on this subject please feel free to post them below.

Best Regards,
Dave

[pjethwani]

Hi David,

thanks again for the answer...

so continuing further from your response ...

wouldn't technical indicators like MACD, ADX etc. become less and less effective with time as everyone knows about them?

sorry I am very new to trading, so I don't know the different between a Trading System and Technical Indicators. May be I am missing something fundamental.

- Paras

[David Waring]

Originally Posted by pjethwani

Hi David,

thanks again for the answer...

so continuing further from your response ...

wouldn't technical indicators like MACD, ADX etc. become less and less effective with time as everyone knows about them?

sorry I am very new to trading, so I don't know the different between a Trading System and Technical Indicators. May be I am missing something fundamental.

- Paras

Hi Paras,

Good question. A trading system is any set of rules for entering the market, managing a position once you are in the market, and for exiting the market. While certain indicators can be used as trading systems for the most part they were designed to be used as part of a trading system and not a stand alone system. In other words they are there to give you an "indication" of some part of the market such as trend or momentum in the market.

This is why if you notice in my videos I constantly talk about confirming your trading decisions with different pieces of analysis and not just using one thing.

Hope that helps.

Best Regards,
Dave

[alanhatcher]

A simple example demonstrating this isn't true in most markets is A buys a stock for $50 a share, sells it to B for $60, who, after a period of time, sells it to C for $70. This is essentially the theory behind investing long term in stocks, that over time they will grow with the economy and inflation.

However, your question does hold true, I believe, in commodity and currency markets because for every long positions there is an exactly offsetting short position, thus a zero sum game, ignoring commissions. If the long position gains $2 a unit, the short position loses $2 a unit, and vice versus.

I think Dave can tell us whether this is 100% true in these markets.

Terrific site, more information in one place than I've found anywhere else.