The tendency of a profitable strategy to weaken over time as competitors find it, capital crowds in, or the market structure changes.
Decay has three causes worth separating. Crowding: more capital trading the same signal moves the price earlier, so the move you were capturing happens before you get there. Structural change: decimalisation, new venues, or a rule change removes the mechanism. Fitting: the edge was never there and the live period is simply revealing that.
Distinguishing them matters because only the third means you did something wrong. Monitor the effect size, not just the profit: a signal whose average per-trade edge has fallen from 18 basis points to 4 is decaying even if the equity curve still rises on higher turnover.
Practical response: set a retirement rule in advance. For example, stop trading if the rolling 12-month information-ratio falls below zero for two consecutive quarters.
Original diagrams for the ideas on this page. Illustrative, not real market data.
Expectancy: the average trade. Forty trades sorted by outcome: 24 small losses and 16 larger wins. Weighting each side by how often it happens gives the average result per trade, marked here by the dashed line at +$120.
Educational only, not advice. Spotted an error? Post in Site Feedback.