Sunday, July 27, 2008

Automated Trading Systems

Before I started this article I checked my mail box was bombarded by no fewer than 10 emails promoting new trading systems, automated trading systems and a lot more.

Each one promised that it was better the any other system that had ever been traded before, each one promised a money back guarantee, and had a dozen testimonials from various traders round the world. Some even went so far as to say that you don't have to know anything about trading, just load their system sit back and watch yourself become very wealthy.

Again I must emphasise that most of these systems are unknown to me and I cannot say that without any shadow of a doubt they either work or don't work. I just keep going back to the supposed fact that if 90% or more of traders out there are still losing their money, then what is the real truth. With all these amazing systems available to all and sundry," how can this be possible?" Surely we should all be making a killing in the market and only a small % should be losing

The stats bandied about in forex circles suggest that 90% of all traders entering the market wind up losing their capital. I cannot vouch for these stats as I have no idea where they come from, or seen any official publications based on scientific research to support these stats.

I am not suggesting that these figures are not true, only that some factually based regularly published statistics would help to emphasize the real risks for new participants entering the market.

With so much hype and advertising about the potential rewards the forex market has to offer and only a general CFTC warning about the risks, the question is?, "are new traders or investors not entitled to the actual facts rather than an arbitrary warning."

The only organisations who can provide the necessary data are the trading platforms. Maybe someone should suggest to the NFA (National Futures Assn.) and CFTC (Commodities Futures Trading Commission) that each registered Market Maker, Broker, Trading Platform make the following stats available.

1 Number of traders with live trading accounts.
2 Number and percentage of traders who lost money during the report period.
3 Number and percentage of traders who made money.
4 Number and percentage who broke even.
5. Total amount of capital lost by the losers
6 Number of traders who lost all their capital and the total amount involved.

These two controlling bodies should then compile the stats from all concerned and publish the figures on a quarterly basis, which should then be made compulsory so that anyone wishing to to advertise any forex related product have these stats clearly visible on their ad or marketing material.

The FDA (Food and Drug Administration) require strict health warnings and labels on food, drug and tobacco products to protect our physical health , should we not be entitled to the same protection of our financial health?

The question is will this have any affect on the number of new participants entering the market?

Here's an analogy, I am sitting with a packet of 20's cigarettes in front of me with the following clearly written highlighted warning on the front of the packet "Every time you smoke those around you smoke too. Your smoking increases the risk of lung cancer and heart disease. Stop smoking for the sake of you health and that of your family and friends. For more information call...."

There are numerous different warnings on cigarette packaging in our country, smoking in public places restaurants and bars have been banned.

Has this stopped kids and adults from starting, or had a major effect on the bottom line of tobacco companies? I don't think so. Yes! there has been a slight reduction in numbers but people can no longer say I did not know. They can make an informed decision based on fact and clear warnings.

Brokers and trading platforms keep impressive and extensive accounting records for every trader and the figures should not be difficult to extract. These figures would go a long way to providing potential new comers with the true facts.

I do not think it will have a major effect on the number of new participants entering the market simply because human nature dictates that we rise to the challenge and believe that we can be rated among the 10% who can actually make money in the market in spite of all the evidence to the contrary.

If the NFA and CFTC are really serious about weeding out and putting a stop to much of the bogus marketing splurb that promises the earth and delivers very little then these stats should go a long way towards deterring a lot of people who do not have excess funds available as risk capital from getting involved in trading.

Having said all that I firmly believe that anyone who wishes to trade should be given the opportunity, after all life is all about learning new skills and rising to new challenges. The true stats however will help potential new traders make an informed decision based on fact

I am also not suggesting that all the marketing and advertising is bogus. There are many great traders out there with great trading systems that have the potential to earn traders vast sums of money if the trader has the discipline to follow the rules of the system.

I have never been a fan of automated trading systems, and have tested numerous over the past year or two. I unfortunately have not found a single one that lived up the its marketing promises. That is until almost three months ago a friend sent me an EA (Meta Trader Expert Advisor or automated trading system) that he had developed and asked me to test it.

The EA is account specific so it cannot be copied or pirated without the developers permission. It is also not available to the general public for sale as it was developed strictly for their own use.

This article is also not to promote it in any way or sell it but simply to highlight the pitfalls and the potential of automated systems.

When he sent it to me it came with specific instructions. Only trade an account of $25 K or more with at least 200:1 gearing. Only trade the GBP/USD pair and only trade 10c lots. Do not trade more than one currency pair and keep to the default settings. The instructions were clear and concise and did not require a rocket scientist to understand them.

I duly, with much scepticism opened a new demo account with a balance of 25K to test the EA but failed to ensure that it was a mini account or that the gearing was 200:1. The first few days were impressive as I was trading 1$ lots and not the recommended 10c and the balance began to grow steadily, I thought, "hey this is a great EA I am certain at this rate I can double my capital every week or so with no effort from my side".

That's where human nature took over and I decided to add the GBP/JPY to the fray as well, the balance continued to rise. I spoke to my friend he told me I was a lunatic trading 1$ lots and two pairs with only 25k. I still did not fully understand the significance of his instructions as the EA was raking in the $'s every day. Greed then took over and I added a third pair, the EUR/JPY to the fray and now had three pairs running, determined to prove the system could meet my greedy expectations.

That's where everything went pair shaped and I took a 16k loss dropping the balance to 13k because I ran out of margin and the new orders were rejected. I duly closed the GBP/JPY pair as that was the one that that caused the bulk of the loss. Over the next week or so the the balance returned to 25k with 2 pairs running and then disaster struck once more with another 8K loss.

24k in losses to learn a simple lesson, (follow the instructions) and I am certain there are many traders out there who take those risks on live accounts and then wonder why the system did not work. So it was back to the drawing board and reduced to one pair GBP/USD trading 1$ lots. Still not according to instruction but the best I could with the account I opened. The major problem though was the account I opened only allowed gearing of 50:1 not the recommended gearing which caused a few problems.
Click to Enlarge

The Above is the equity curve and balance taken from the detailed trading report that clearly shows the two losses. I did have to make another adjustment to the inputs that differ from the default to cater for the low gearing and the fact that I was trading 1$ lots instead of 10c lots. The results were impressive once I followed the rules and were it not for human folly the balance would have tripled in the three month period of testing.

The above is a perfect example of how human nature can ruin a perfectly good trading system and I have no doubt that a new trader without any knowledge of how Gearing, margin and lot sizes affected an account, would have wiped out the entire 25K in the first month.

I would not recommend the EA unless the trader could prove he had a mini account of 30k or more and was disciplined enough to stick to the rules. It is certainly the best and most consistent EA I have tested as the balance increases daily and I cannot remember when last there was a negative balance on a trading day.