Here's a question that separates serious systematic traders from hopeful ones: how long does your edge actually last? Most traders spend months building a signal, backtest it obsessively, then deploy it — never once asking whether the alpha has a use-by date. Spoiler: it almost always does. The gap between "my signal works" and "my signal works at this specific holding period" is where most strategies quietly bleed out.
Signal decay is the measurable decline in a trading signal's predictive power as the holding period extends. Think of it like fresh bread. On day one, it's brilliant. By day three, still fine. Day seven? Something's gone wrong and you should have known earlier. Every alpha source — momentum, mean-reversion, earnings drift, order flow — has its own decay profile, and ignoring that profile means you're holding positions long after the informational edge has expired.
To build a decay curve, researchers typically compute the information coefficient (IC) — the correlation between a signal's predicted rank and actual forward return — across multiple forward windows: 1-day, 5-day, 10-day, 21-day, 63-day. Plot those ICs and you've drawn your decay curve. A sharp drop from day 1 to day 5 signals a high-frequency edge. A flatter curve that holds through 21 days suggests a slower structural inefficiency. The shape tells you everything about optimal holding.
Practically, once you've mapped your decay curve, three decisions become clearer. First, set your exit rules to match the IC half-life — the point where the IC drops by half from its peak. Second, watch transaction costs: a signal with a 2-day half-life might look brilliant on paper but get eaten alive by brokerage and spread at high turnover. Third, layer signals with different decay profiles to smooth out the equity curve across regimes. For deeper grounding on the mechanics, Investopedia's explanation of the information ratio connects IC directly to risk-adjusted performance, while Wikipedia's overview of alpha in finance contextualises what you're actually measuring when you track signal decay. AQR's published factor research, well summarised via Investopedia's factor investing primer, shows empirically how decay profiles differ across value, momentum, and quality factors across decades of data.
Measure your IC at every holding period before you trade a single dollar. Your edge has an expiry date — the only question is whether you've bothered to read the label.
This content is for educational purposes only and does not constitute financial product advice. Past performance is not indicative of future results. Profit Logic Ltd (ACN 688 669 936) accepts no responsibility for errors or omissions in this content or anywhere on this website. Always seek advice from a licensed financial adviser before making investment decisions.