The latest evolution in trading that is making the rounds of
traders around the world are forex robots, or expert advisors. Forex
robots are mathematically derived systems that predict movements in
currency markets and enter trades on the trader's behalf, completely
automating the trading process. All the trader does is purchase the
robot, upload it to an appropriate platform, fund their account and turn
it on.
Expert advisors have been used profitably by investment
and trading banks for many years and have now made their way into the
"retail" world. The idea came after the cold war ended, when trading
banks discovered that they could employ mathematicians at a low price.
The trading banks combined the maths experts with I.T. experts and the
end result were automatic trading systems.
Some however feel that
these products may be too good to be true, or a scam. While we are not
assuming that every single robot manufacturer is trying to take
advantage of the trader, most would be well versed to understand exactly
how they work and what can realistically be expected from them. The
scam impression generally comes from "someone knew someone who once had
an expert advisor." It usually revolves around the idea of the robot
having a bad patch. All robots have a bad patch and no robot
manufacturer to our knowledge claims a 100% success rate.
Expert
advisors usually utilise technical analysis for their trade signals.
Technical analysis is the use of chart formations and mathematical
algorithms to define future movements of financial markets. Technical
analysis is now a broadly accepted way of trading, with many believing
that this is actually the only way to trade short to medium term price
movements profitably on a consistent basis.
Additionally, expert
advisors also have their own money and risk management algorithms. These
systems can either use the default settings, or else be set by the user
to allow tailoring towards individual trading needs. Risk management
generally revolves around maximum trade size, maximum risk per trade
(stop placement) and number of trades to be initiated at any one time.
Robots
take their advantage in that they can both analyse and execute trades.
This means that very small projected price moves, of as little as a few
pips, can be taken advantage of. These are the type of trades that are
usually taken by "scalpers." Robots tend to work well in liquid, fluid
markets that are cheap to trade, which makes them perfectly suited for
foreign exchange.
The complaints usually arise when a robot hits a
losing patch. Like all traders, robots also get the market wrong at
times, and the trader can feel extremely disempowered when a "machine"
is losing their money. The trader needs to know from the beginning that
this is an inevitable part of trading.
The object is to utilise
the benefits of trading financial markets with expert advisors and
limiting the negative aspect of suffering a bad patch. The best way to
do this is for the trader to utilise some diversification their
automatic trading strategy.
Diversification, also known as
portfolio theory is the act of reducing the risk of negative returns in
any one robot, by utilising two expert advisors at the same time.
Diversifying the trading robot strategy will at times result in both
robots profiting at the same time. At other times, when one robot is
performing poorly, it is hoped that the other will perform well and
counteract the losses on the first. It must be clear however that there
is a risk that both robots will perform poorly in tandem.
It is
best to combine expert advisors of different trading styles to ensure
that they complement each other. This can be done by purchasing one
robot that specialises in short term price movements in addition to
purchasing another expert advisor that seeks to profit from longer term
price moves.
The final word on diversification of the trader's
expert advisor strategy is allocation. It makes the most sense to
allocate even amounts to each robot. For example, if you are using two
robots, allocate 50% of your funds to each. This will ensure that the
trader is not "gaming" the individual robots by trading against them.
Hamilton Rhodes is an Australian based brokerage providing execution and research in all asset classes.
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