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From the Introduction to the Ocean Theory Book:
We could say that a freely traded market is in the business of digesting information and rendering it useless. That is, the market is an organism for metabolizing information, and as with any organism, once food is metabolized it is no longer useful.
In the case of a free market, the information that the market seeks can only come in the form of buy and sell orders. The market itself has no other way of receiving any information.
An example. Let’s say that a hundred people in the world know that a severe draught is going to affect the price of coffee next month, but that they have told no-one else and also have done no buying or selling based upon what they know. Does the coffee market “know” this information yet? No, it’s completely unaffected by it.
Only when some person or institution starts buying or selling based upon that information can the market begin to receive it, and the more people or institutions who do so, the more the market can be said to “know” this particular piece of information.
When that piece of information is widely known among those who participate in that market, and corresponding long or short positions have been taken based upon it, then the market can be said to have fully digested or discounted the information available up to that moment, and it is no longer possible to make a profit based upon that information, unless the information changes.
At that point the information may be fascinating and even accurate, but it is no longer possible to make a profit upon the information, simply because a market has no way of distributing free money to those who don’t possess some food that the market hasn’t digested yet.
Only if one possesses information that most other market participants don’t know yet does the potential of a profit based upon that information exist. Perhaps this precept seems obvious, but in practice it is violated chronically by most traders.
Of course, one can always make a profit by accident or luck, but trading that is profitable long-term cannot be based upon the whims of luck for obvious reasons.
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Basically, there are two types of information available to participants in a free market:
The first type is what is called “insider” information. If you know that IBM is going to raise its dividend next month, and this is not public knowledge yet, you could profit very handsomely through your inside information. However, the downside of this approach is that profiting from this type of information is illegal in most countries.
The second type of information occurs if you can usefully analyze a market, from public information, in a way that only a few market participants know about. In this case you would also have “inside” information, but in a way that is legal and usable.
The error comes when we acquire some system or method of approaching the markets that has become widely used. No matter how adroit that system or approach may have been, as it is more widely used by market participants, its consistent profit potential must go down, because the market is increasingly digesting this information.
As a free market increasingly digests a particular way of analyzing or approaching that market, the approach may still be useful in an academic sense or as a subject of intellectual fascination, but it must become less and less efficient as a profit-making engine because it has the same life-span decline as any other “insider” information that is becoming public knowledge.
What usually happens is this: Wykoff or Gann or some other brilliant analyst comes up with a theory or set of theories that look at markets in a new way, the newer and more radical the better (because that way it is less like other systems that are already known by the market). And with this new approach the analyst makes successful profits or predictions.
At length he/she publishes the theory, but its knowledge and acceptance into the marketplace is slow at first. It is simply not very widely known yet, and for that very reason its profit-making potential continues, though slightly diminished because it is known by a few more participants.
As time goes on and the theory becomes more widely known, though, its profit-making potential goes down even though it continues to make predictions that are sometimes fulfilled. What happens is that the predictions become more “sloppy” on average.
If a turn, say, is predicted for such-and-such a date, the turn might come earlier than it otherwise would as more participants take positions anticipating the turn. Or the turn might become more rounded instead of angular. Or
it could become sloppy in other ways.
In any event the profit potential goes down on average as the market becomes increasingly in possession of this information. Of course any particular prediction could—for various reasons—be as accurate as before, but the predictions on average become less amenable to profits.
Finally the theory becomes very widely accepted and acclaimed, and ironically, it is just at this point that the theory stops making money on average for participants. Particular participants or predictions may get lucky, but
in general the system or approach is much less effective.
As time goes on, even though the theory or approach is widely acclaimed, participants who are alert begin to notice that they are not making money on average using this approach. In fact, they begin to have losses using it because the market can see them coming.
And as this becomes slowly known, the theory or system becomes less popular and is slowly discarded by more and more people. Finally it becomes relegated to the dust-bin of market history—interesting perhaps, but considered discredited or irrelevant.
As this happens, its profit-making potential begins to pick up again and the few participants who are using it begin having some good successes. And they tell their friends or associates—and the cycle starts all over again.
But not quite. Instead of just oscillating back and forth between popularity and unpopularity, that is, between non-profitability and profitability, the system or method usually settles into a kind of symbiosis with the market, whereby those participants who are using it make on average neither profits or losses.
And that, of course, means that they’re taking losses on average, because of transaction costs, bid-asked spreads, and other sources of friction against profits. Yet the approach still has some successes, especially among those who are particularly skillful at applying it, and these successes are widely touted. And so the game continues.
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How, then, should a trader or investor approach the question of market systems? In my opinion, the only way to stay ahead of the market’s continuous digestion of information is to, in effect, follow these steps: #1) find something unique #2) that is automatically self-adjusting, and that #3) is made available on a limited basis (the Ocean Software in particular is sold on a limited basis).
Ocean has that quality. Since Ocean is, in effect, the market's own analysis of itself, it is continuously adapting itself to the market's condition without being programmed to do so. That is, this self-adjusting quality of Ocean is not artificially programmed in—which would inject yet another aspect of arbitrariness—but arises naturally from the very nature of Ocean Theory itself.
—jim sloman
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