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A robust strategy versus a robot strategy

Robot on trading floorThere are several options open to new traders looking for a route into trading. They can sign-up for a robot system, they can teach themselves through trial-and-error, or they can learn from more experienced traders.

Robot Strategies

Robot strategies come by many names: black box, algorithmic, or copy trading to name a few. The one thing they have in common is you won’t fully know how the signals are generated. You are reliant on past performance to predict future success and if the strategy stops working you have no idea what drawdown to expect before it starts to perform again.

Occasionally you are given vague details on the types of market conditions appropriate for the successful implementation of the strategy. And you may even be told what market indicators – although not what settings – are used to create the signals.

Algorithmic systems are generally those which are generated from computer programmes – although in reality any systematic set of rules is technically an algorithm.

These systems are rigorously backtested to obtain the very highest profits – but at a cost. And the cost isn’t necessarily in the upfront or monthly fees charged (which can range from a few hundred dollars to many thousands of dollars).

There are two main disadvantages to robot trading:

  • curve fitting
  • the analysts

Most robot strategies are vigorously tested – sometimes over 10 years worth of data but frequently a lot less. It will be very accurate but this is also its weakness – to get the most profit from the markets the algorithm will be tweaked continuously to fit the back data. This is called curve fitting. Anyone who has even a small amount of trading knowledge knows that it is easy, with hindsight, to see the best places to enter and exit trades. It’s knowing what to do AT THIS MOMENT which presents challenges.

If the algorithm is created using data from a strong bull market, for example, it may not be profitable if the market tails off or reverses into a bear market. But if you are not told what conditions are optimal for the algorithm how do you know when to stop using it?

The second weakness of robot systems are the analysts. Although most systems will originate with a trader’s proven strategy, it will have to be amended in some way to address the volume of trades it will generate. Once it gets into the hands of the analysts, however, it will inevitably change its nature. Analysts are analysts – not necessarily traders. For optimal profits, for example, they may decide a 90% drawdown is acceptable for a 100% return. There are very few traders who would find this acceptable – in theory yes, but in practise it would be very hard to stick with such a succession of losing trades.

TDT Tip: If you are interested in being a trader you should learn how to trade. Following, blindly, someone elses strategy – with your only decision to copy or not – won’t make you a trader. You are reliant on that system to keep providing for you forever.

Robust strategies

A robust strategy is one where you understand its components, it is proven to work, and you are comfortable implementing it.

If you fully understand your strategy and how it is constructed, you will know how it will react to certain market conditions and if need be, when to turn it off and stand aside in the market.

A stumbling block for many new traders, who go this route, is that although they understand the construction of their strategy they may not understand the components. For example, Stochastic is a popular charting indicator but could you explain how it is calculated – to a layperson – in no more than 20 words? Yet thousands of traders rely on this indicator to get in – and out – of trades every day (or even several times a day!).

TDT Tip: Simple trading strategies are more effective than complicated strategies. Have a read of my article “Are your chart lit up like a Christmas tree?”.

If you don’t understand how an indicator is calculated then you should avoid using it. Trust in your strategy is essential to successful trading.

If you are using another trader’s strategy (with their permission, of course!) you should have full access to how it works – and take the time to fully understand it and all its components.

Usually, when first using someone elses strategy, you begin with complete faith. After all, it belongs to someone who made money using it. But if you don’t take the time to understand how it works in its entirety then after a while – or a few losing trades – you will begin to doubt its efficacy.

You must be clear as to what market conditions it is designed for – there is no generic strategy that can work regardless so you must make sure you understand it. Finally you must implement it correctly. You may need ongoing support for this, so bear this in mind at the outset.

Think carefully about using another trader’s strategy. Make sure your philosophy is in line with theirs. FYI “Get Rich Quick” is not a valid philosophy. Think hard about your long term goals and the minimum returns that are acceptable to you. Be realistic in how long it will take to master both yourself and the markets.

Conclusion

Trading is not easy but it is simple although often made complicated. Fully understanding your trading strategy is an essential component of successful trading for private traders. Gain a trading edge by learning your strategy components, the optimal market conditions it works in and when it is best to stand aside in order to preserve your capital.

Wishing you all successful trading…

Anne Chapman

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  1. Jay - October 24, 2014

    tnx for info!!