Why most strategies fail (and what TrendBot teaches)
If these rules worked reliably, everyone would be rich. Here's why they don't.
Costs and taxes eat small edges
Active strategies trade often. Each trade has costs (spreads between buy and sell prices, sometimes fees) and, in a taxable account, short-term gains are taxed at higher rates. A strategy that beats the market by 1% a year before costs can easily lose after them.
Overfitting: rules that only fit the past
Try enough rules on old data and some will look brilliant by pure chance. That's overfitting: the rule memorised the past instead of learning something real. It usually stops working the moment it meets new data. A related trap is survivorship bias: studying only the stocks or traders that survived makes the past look easier than it was.
Markets adapt
Prices quickly reflect widely known information, an idea called the efficient-market hypothesis. Markets aren't perfectly efficient, but once a simple pattern is public, many traders exploit it until it fades. That's why simple chart rules rarely keep an edge.
Most professionally managed stock funds trail a simple index fund over long periods once their fees are counted.
The TrendBot experiment
TrendBot on the Play page runs the open-source tool's 100-point checklist every day with play money and real prices, in public. Compare it with the S&P 500 over the coming months. Whatever happens, you learn something: if it wins, ask whether it's skill or luck; if it lags, you've seen why most investors are better off with a low-cost index fund.
A strategy earns 9% a year before costs; the index fund earns 8% and charges 0.03%.
The strategy trades 50 times a year at about 0.1% cost per trade (5% a year), and short-term taxes take more. The 1% 'edge' turns into roughly 4% a year behind the index before taxes, and further behind after them.
Key terms
- Overfitting
- A rule tuned so closely to past data that it fails on new data.
- Survivorship bias
- Drawing conclusions only from the winners that are still around.
- Efficient-market hypothesis
- The idea that prices quickly reflect available information.
- Backtest
- Testing a strategy on historical data to see how it would have done.
Most strategies fail because of costs, overfitting and competition; a low-cost index fund is the hard benchmark to beat.