5. Automated Market Analysis
We turn now to analysing markets to find trades. Here we begin to answer the questions regarding which markets to trade, in what direction and over what time period. This is a huge area and it would be possible to spend a lifetime reading a library of books on the subject. First, however, it is worth discussing briefly a way in which it may be possible to find trades without undertaking any analysis.
The availability of access to increasingly powerful computers over the past couple of decades has caused the idea to really gain popularity that market analysis can be automated leading to the popularity of mechanical trading systems. The systems themselves are not mechanical in any sense, they are merely computer programs running statistical processes. What is mechanical is the way in which they are used in terms of decision making: the program identifies a trade and the trader, if involved at all, then places the trade without further questioning. In other words, the response to the signal is mechanical.
The growth in popularity of Binary Options has led to a growing industry of supplying such systems to traders. It’s not difficult to see why this might be so. Binary Options are attractive to inexperienced traders who may not have a good knowledge of how to analyse the markets or develop a trading system. So a software program that automates the process and provides a signal appears to be an attractive tool. So, do such robots have a place in a trader’s toolkit? Are they a good investment? First, understand what these robots are doing. They are analysing market data, often using quite simple processes, to identify when certain patterns emerge. When the program is run on a particular market it does a calculation and provides a signal. Vendors of signaling software or robots often claim success rates of 80% or even more, the implication being that if you took the trade in line with the signal then you will have a winning trade 80% of the time. This sounds good, but is it too good?
Compare it with the results that are obtained by most traders and the success targets of the main authors. In general, financial traders in traditional sectors aim for success rates in the range of 40 to 45%, although day traders will look for higher. With good money management you will be very successful if you achieve this. In Binary Option trading as no stops are required it is reasonable to expect that random trading will produce 50% success. But since this market is basically a zero sum game – for every winner there is a loser of equivalent $ amount – plus there are costs, then it must be the case that the average trader is returning less than 50% in dollar amounts i.e. the average trader is not breaking even.
A success rate of 80% with a payout rate of 80% would mean that after 100 trades of $10 each the trading makes a profit of $440. Assume that we are trading with 2% risk per trade and 5 trades per day. It would take about a month to reach 100 trades. For $10 risk per trade then the fund must have been $500 to start. We would have made a profit of 88% in a month. The next month we can increase our trade size to $18.8 as we add our profits to the find and so on each month. In 1 year, at the start of month 13, our fund will have grown from $500 to over $1 million. So, in a year, you’re a millionaire. Does this seem a reasonable expectation to you? If it’s that simple, why isn’t everyone doing it? Any why are all the traders in traditional markets not using these simple programs instead of aiming for returns in the region of 10 to 15% per annum?
Clearly there’s something wrong here. The providers of these software products are probably not lying if they say that testing has produced 80% success. Instead, they have run a program on a past data set and identified a set of parametres for various statistical indicators that best predicted what happened next in that dataset. It is conceivably possible that this could be correct 80% of the time. However, it’s a whole different matter to try to predict what will happen next into the future.
So, do these programs work? Some systems will be total failures while some may have a role to play within a trading system as an aid or an alert system. But that, in my opinion, is all. I am not saying you should not have a look at automation. If you are considering buying such a program and there are claims in relation to its success, ask if the claims are based on back testing or are based on live trading. I’ve tried this a few times and have yet to get a clear, convincing answer and so I have drawn my own conclusions.
A further development of this that appears to be common in the Binary Option sector is that you sign up to a mechanical trading system with the broker who then automatically trades your fund without any input from you. Sometimes this is described as having your trading undertaken by an expert.
Don’t go anywhere near these offers. You will lose your money. Remember, the broker wants to ensure that you trade very often as that is how he makes his money. If the ‘expert’ was really that good he would be retired to the Caribbean, not trying to entice you to put up your small fund. The fund will simply be traded by an automated system that might be as good as you, but will lose your money. A far better approach is for you to keep control of your money, learn how to trade and get better. If you don’t take this responsibility then don’t complain afterwards.
There is one further point also. A number of the programs are quite reasonably priced and, if they are useful by increasing the success rate by even a couple of percentage points, a trader would soon recoup the cost. However, many of them also come with instructions that you must open an account with a certain broker, or up to 5 different brokers, in order for the signal to work. Various reasons may be given but this is really just a sophisticated form of affiliate marketing. The software providers are able to supply the software quite inexpensively as they makes their money from commissions paid by brokers for new recruits. Don’t fall for it.
In conclusion, I don’t think that automated signaling or trading should replace your own analysis using a system that you understand and that you implement consistently. Automation can be beneficial within a system by providing alerts that defined patterns have occurred in a certain market. It can also be important in providing a constraint to ensure that the rules of the system are maintained and in managing information. But these objectives are quite different. Seeking the ultimate automated system serves to divert traders from concentrating on learning how to undertake good market analysis.