Trading the capital markets is a business. Thus, it would help if you had a plan similar to a business plan that incorporates your risk management and several strategies that will allow you to make money during different market conditions.
Fortunately, there are several different methods that traders can use to invoke their investment methodology. For instance, some use a systematic approach, while others might use a discretionary system.
One option is using a trading robot, a systematic approach allowing a computer program to handle the trading strategy and risk management. However, there are several issues that traders face when using a trading robot, and in most cases, investors do not know the criteria for generating traders and performing risk management techniques. The question for investors is whether a trading robot is worth it.
What Is a Trading Robot?
A trading robot is a computer program that automatically uses a set of rules for forex trading. Trading robots are designed to remove the psychological element of trading, which can often be detrimental to the performance of a trader. Instead, they are programmed to analyze market conditions and execute trades based on predetermined rules and parameters.
Trading parameters are the rules and conditions traders use to determine when to enter and exit a trade. These parameters can include the type of asset being traded, the time frame of the trade, the entry and exit points, the risk/reward ratio, the amount of capital to be invested, and the stop-loss and take-profit levels. The trading parameters can also determine if your trade uses technical or fundamental analysis to determine your entry and exit criteria.
What Is Technical Analysis?
Technical analysis is the study of past prices to determine future price changes. Technical analysis evaluates an asset’s performance by analyzing the statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security’s intrinsic value but instead use charts and other tools to identify patterns that can suggest future activity.
The study of technical analysis will also focus on studies including trend following, momentum, and mean reversion. Technical analysis is widely used among traders and financial professionals and often complements fundamental analysis.
What Is Fundamental Analysis?
Fundamental analysis analyzes security by measuring its intrinsic value by examining related economic, financial, and other qualitative and quantitative factors. Investors and analysts use it to determine the value of a security by analyzing the company’s financial statements, such as its balance sheet, income statement, and cash flow statement.
Fundamental analysis also includes assessing the company’s management, competitive advantages, and market position. Moreover, it refers to analyzing macro events such as an economic situation and how growth and inflation will impact the future movements of a security.
How Do You Use a Trading Robot?
Using a trading robot might seem simple, with the first step involving the selection of a trading robot that meets your needs. You want to find one that incorporates your risk and reward parameters and test it to see if it works in real-time.
Most trading robots provide you with a historical return. Just be wary of any broker or system developer who makes unrealistic claims about the performance of the trading robot they are selling. You must also be very careful if the robot seller will not allow you to test the robot for free. The performance claims of a robot are usually based on historical data, which has been backtested to determine if the robot worked in the past. Remember, past performance is not indicative of future performance.
Backtesting a trading system is testing a trading strategy on historical data to determine its profitability and risk. It involves simulating the process on historical data and analyzing the strategy’s performance over a given period. Backtesting can help traders identify potential flaws in their trading system and make adjustments to improve its performance. One of the benefits of backtesting your own system is knowing exactly what the criteria are to generate buy and sell signals and risk management. If you are using a robot, you are usually not privy to this information and therefore do not understand what has gone into creating the robot.
Unfortunately, many robots are created by backtesting a specific period, a method called fitting a curve. When you fit a curve in backtesting, you are testing the results over a particular period which seems to generate excellent returns. For example, you might test to see if a particular system has worked over the past 5-year period, in which case you wouldn’t look at each year or test the five years before the testing period. A good robot will work during smooth market conditions and volatile periods. It will work when a CFD is rising and when it’s falling. It will perform during choppy market conditions and trending market conditions. Most of the time, you cannot determine if a robot was tested during all of these market conditions.
Once you select a trading robot, install it on your computer or platform. After installation, you must configure the robot to your trading preferences. This scenario includes setting the trading parameters, such as the currency pairs, time frames, and risk levels. Once the robot is configured, you can activate it and let it start trading on your behalf.
One way to ensure that a robot works appropriately is to use it on a demonstration account for an extended period. You want to ensure that the robot can stick to its parameters and not incur large drawdowns. Testing a robot in real time is called forward testing. You can see if the robot works in the current market environment and the type of risk it takes. You can then see if there are small gains and small losses or large gains and large losses. Testing a robot in real-time will provide information about how the robot handles risk and if this meets your risk versus reward criteria. Remember, the larger the reward, the greater the risk the robot needs to take.
What Is a Drawdown?
A drawdown in investing is a peak-to-trough decline during a specific period for an investment or trading account. It is usually quoted as the percentage between the peak and the trough. A drawdown is typically a measure of an investment’s volatility and risk. If your robot shows that the maximum drawdown from inception is 10%, you might not expect more than a 10% drawdown in your account value. If this is your thinking, you need to examine the risk parameters associated with the robot thoroughly. If the robot does not disclose the risk parameters, you are flying blind. Even a recorded drawdown might not reflect the risk that a robot system might experience. Unfortunately, you will never know when the most significant drawdown will occur.
You Need to Monitor Your Risk Versus Reward
When you employ a robot, you must determine if you have any control. Most of the time, the robot runs automatically, and you can either stop it or start it but cannot change it. It is imperative to monitor your risk and the reward you receive when you trade.
Risk versus reward is a concept that describes the balance between the potential benefit of taking a risk and the possible cost of taking that risk. It is a fundamental concept in trading decision-making. The idea is that the higher the risk, the higher the potential reward and the higher the possible cost.
Before you start trading an account, you should always know the ratio of risk to reward that you will use. It would help if you then calculated how this risk to reward would perform over time. For example, if you have a trading strategy that wins once for every two times it loses, then you need to double your gains compared to your losses (nine trades, with three winners and six losers, will break even if you win $2 for every $1 that you lose).
If you do not have this information when you purchase a robot, you are making a business decision about something that you have little knowledge about how it works.
The Bottom Line
The upshot is that there are some benefits to using a robot. The main advantage is that you do not have to sit and watch the screen and make decisions all the time. It also takes some of the emotion out of trading. The negatives are that you do not know what is behind the robot, and therefore, you are making a business decision about something you do not know much about. Without having the criteria used to generate entry and exit points, you have little knowledge of the risk versus reward profile and are setting yourself up for potentially large swings in your trading account balance.
