Signal Degradation

Signal degradation is the process where the predictive value of a specific market signal weakens over time. This happens as more market participants discover and trade on the same signal, effectively arbitraging away the opportunity.

In the context of derivatives, a signal that previously predicted a price move might become less reliable as the market becomes more efficient. Traders must constantly seek new, uncorrelated signals to maintain their edge.

Monitoring signal degradation involves tracking the alpha generation of each signal in a portfolio. When a signal's performance falls below a certain level, it is retired or modified.

It is an ongoing struggle in the competitive landscape of quantitative finance.