Trading Robots: Automated Assistance in the Market

The rise of automated trading, particularly through trading robots or expert advisors (EAs), has transformed the financial landscape. The promise of a tireless, emotionless assistant monitoring markets 24/7 and executing trades at lightning speed is undeniably attractive. However, a closer look reveals that while automation offers advantages, it can also be a recipe for disaster if not approached with caution. I can say this with first hand experience, I've had a taste of both the advantages and disadvantages.

What are Trading Robots?

Trading robots are software programs designed to execute trades in the forex market based on pre-defined rules and algorithms. Traders can set specific parameters for the robot, such as entry and exit points, risk management strategies, and technical indicators. Once programmed, the robot continuously monitors the market and automatically executes trades according to the set criteria.

Robots can eliminate the emotional swings that plague human traders, a significant factor contributing to losses. According to a study by the National Bureau of Economic Research, short-term traders tend to overreact to losses, leading to suboptimal decisions [1]. Robots, devoid of emotions, can execute trades based on pre-defined rules, potentially leading to more disciplined behavior. Additionally, backtesting strategies on historical data allows for refinement and optimization. A 2020 report by Investopedia highlights the benefits of backtesting, noting that it can help identify profitable trading strategies and potential weaknesses before deploying capital [2]. Furthermore, robots can execute trades with incredible speed, potentially capturing fleeting opportunities measured in milliseconds.

However, the limitations of robots pose significant risks. Markets are inherently unpredictable, and unforeseen events like global pandemics or political crises can disrupt even the most meticulously designed strategies. A 2022 article by The Motley Fool emphasizes this point, highlighting how the "flash crash" of 2010, triggered by an algorithmic trading error, caused the Dow Jones Industrial Average to plummet nearly 1,000 points in minutes [3]. Robots, programmed with specific rules, may struggle to adapt to such sudden shifts, potentially leading to significant losses. Furthermore, their reliance on technology makes them vulnerable to technical glitches and outages. A 2019 study by the Bank of International Settlements found that technology glitches can disrupt algorithmic trading, potentially leading to market instability [4].

Perhaps the biggest danger lies in over-reliance. While robots automate tasks, they sh
ouldn't replace a trader's judgment and understanding of the market. Blindly trusting a robot can be perilous. Additionally, some robots come with hidden costs, such as subscription fees or complex customization requiring coding knowledge. Ultimately, a poorly designed strategy, regardless of automation, will likely yield poor results.

The foreign exchange market, or forex for short, is a fast-paced and dynamic environment. Traders constantly analyze market movements, execute trades, and manage positions, all in pursuit of capitalizing on currency fluctuations. But what if there was a way to automate some of these tasks? Enter trading robots, also known as automated trading systems or expert advisors.

How trading robots (Expert Advisors) are used

There are many ways in which trading robots could be implemented and set up but the most common platforms where they are used are on MetaTrader 4 (MT4) and MetaTrader 5 (MT5). The programming language used on these platforms are MQL4 for MT4 and MQL5 for MT5. Platforms like forex brokers, stock brokers and crypto exchanges that do not use MT5 or MT4 but allow automated trading will usually have a platform specifically designed for the development and application of trading robots. In some cases, these robots are developed in popular powerful programming languages like python and imported to their trading platforms.

Developing a trading robot could be as simple as writing a few lines of code or as complex as writing multiple thousands of lines of code. Complexity will largely depend on the functionalities that are defined by the trading strategy that is being implemented. 

The first ever robot I developed took me a few hours because the strategy I was implementing which consisted of buying and selling a particular asset at a particular time each day was quite simple and straight to the point. However, for my final university project (I studied computer science), it took me just over a month to fully implement, fowardtest (short-term; 1 month is not a long enough period to foward test a robot.) and backtest my robot.

Gradually, classical Forex trading bots are being replaced by neural networks with machine learning. Based on the input data and set targets, the best Forex trading robots are able to calculate thousands of mathematical algorithms, choose the best one and independently adapt to Forex market changes. So far, the best Forex robots are used only by the largest investment companies

How to Select Trading Robots

Selecting a good trading robot can be a quite challenging as there are many factors to consider when making this decision. First and foremost, you have to understand the tools you are using in trading, otherwise, you cannot be sure of success in the markets. 

You will surely see beautiful profitability charts on Forex trading websites with ads of profitable advisers, something deep inside you will stir, you’ll get a thought like “what if it’s true”‎, and it will make you feel very warm. Unfortunately, it is the same greed that whispers to people who lose money in slot machines. And the more willing you are to listen to it, the worse for your financial situation. Don't let greed defeat your common sense as you will be risking your real deposit. That inner voice cannot make up for what you lose if it fails.

• Trading Style: If you decide to try automated trading systems with trading bots, the right decision would be to use the trading robots whose mechanism is clear to you, at least in general. Do not be fooled by general phrases like “‎the advisor is based on a super-profitable algorithm that instantly adapts to market changes and protects against sudden price spikes”‎ or “‎the advisor’s algorithm is too complicated to describe, it has a lot of latest technical analysis indicators (MA, support and resistance levels,etc.), but it perfectly selects time and place for trades”. It's like when buying a car you believe the seller that says "the car is good, I would drive it myself, but I don’t have the money"‎ without even taking a test drive. You don't do that in real life, do you?
• Risk Management: The risk management method here should be well defined and tested to work, for example there are Forex trading bots with Martingale coefficient, they increase the position volume in case of a loss. They are high risk Forex trading robots.
• Testing: Test the Forex trading bot using a tester. While your Forex robot operates continuously, focus on these key aspects: 
• Equity Pattern: Monitor the equity curve, which should ascend smoothly. Abrupt declines may indicate a Martingale strategy and instability when the Forex system faces consistent market changes. Pay close attention to the recent equity trend - if it flattens out or shows a downward trend, the advisor may not be functioning optimally. Maximum 
• Drawdown: A larger drawdown is undesirable. It's challenging on a live account to determine when to intervene manually with the advisor to protect at least a portion of the minimum deposit. 
• Consecutive Losing Trades: Keep track of the number of consecutive losing trades, which should remain reasonable. Having 5 or more consecutive losses suggests an issue. 
• Profitable vs. Unprofitable Trades: Ideally, the ratio of profitable to unprofitable trades should be balanced. If there are significantly more losing trades, it indicates that the Forex trading bot is initiating numerous small losing trades and compensating with one large profitable trade. While this strategy is acceptable, it carries high risk.
• Source code Accessibility: Though not a necessity, I would recommend getting and using open source trading robots, not just compiled already packaged robots as this gives you more flexibility to work on and improve your trading robot as you please. Some programmers offer Closed code robots (.ex4 for MT4), this means that you cannot view and modify the source code. For an investor, this is a disadvantage. Look for open source Forex trading bots.

 

Pros of Trading Robots

1. Enhanced Efficiency: Trading robots operate 24/7, leveraging the forex market's continuous nature. This round-the-clock monitoring ensures that trading opportunities are swiftly acted upon, even during off-hours, maximizing potential profits. 
2. Emotionless Execution: By removing human emotions from the equation, trading robots adhere strictly to predefined rules and strategies. This discipline prevents impulsive decisions influenced by fear, greed, or overconfidence, leading to more consistent and rational trading outcomes. 
3. Backtesting Precision: Before deploying capital, trading robots allow for rigorous backtesting on historical data. This process enables traders to assess strategy effectiveness, identify potential flaws, and make informed adjustments, ultimately refining strategies for optimal performance in live markets. 
4.  Speed and Agility: Trading robots execute trades with remarkable speed and accuracy, capitalizing on fleeting market opportunities that may arise within milliseconds. This agility is crucial in fast-paced forex environments where swift action can mean the difference between profit and loss. 
5.  Risk Management: Through predefined risk management parameters, trading robots help maintain consistent risk exposure. Features like stop-loss orders, position sizing rules, and risk-reward ratios ensure that trades are executed within a trader's risk tolerance, enhancing overall portfolio stability.
6. Multiple Scenario Applications: Trading robots with the right expertise, could be programmed to carryout a variety of functions without needing the intervention of a human. They could be applied in multiple use cases such as technical analysis and fundamental analysis. There is an increased market awareness where robots could scan many assets at a time and carryout detailed analysis in a very short period of time, something that is impractical for any regular or even professional trader, in my experience analysing more than 5 assets without making mistakes while actively trading requires a high level of skill and experience. This is something a robot will easily do given the parameters and actions have been properly set.

Cons of Trading Robots

1. Limited Adaptability: Markets are inherently unpredictable, and unforeseen events can disrupt even the most meticulously designed strategies. Trading robots may struggle to adapt to sudden market shifts or unforeseen circumstances. Human traders often excel in interpreting nuanced market conditions and adjusting strategies accordingly, a level of adaptability that robots may lack.
2. Technological Vulnerabilities: Trading robots are software programs susceptible to technical glitches, bugs, connectivity issues or data inaccuracies. These vulnerabilities can lead to unintended trades, order execution delays, or system failures, potentially resulting in financial losses or missed opportunities.
3. Over-reliance & Lack of Oversight: While robots can automate tasks, they shouldn't replace your judgment entirely. It's crucial to monitor your robot's performance and intervene when necessary. Forex trading requires a deep understanding of the market, and blindly trusting a robot can be dangerous. Traders must remain actively involved in monitoring robot performance, verifying trade executions, and intervening when necessary to prevent significant losses or deviations from the intended strategy.
4. Hidden Costs & Complexity: Some trading robots come with subscription fees or require coding knowledge for customization. The complexity of setting up and maintaining a robot can be a hurdle for new traders.
5. Not a Guaranteed Path to Success: Trading robots are tools, and like any tool, their effectiveness depends on how you use them. A poorly designed or backtested strategy will likely yield poor results regardless of automation. Success ultimately hinges on the quality of the underlying trading strategy, proper risk management, and ongoing monitoring and refinement, factors that cannot be fully automated or guaranteed by robots alone.

Conclusion

Trading robots can be valuable tools for forex traders, offering benefits like 24/7 operation, emotionless trading, and faster execution. However, they are not a magic bullet for success. Before deploying a trading robot, it's crucial to understand their limitations, develop a sound trading strategy, and maintain close oversight of the robot's performance. Remember, forex trading carries inherent risks, and trading robots shouldn't replace your own knowledge, risk management skills, and prudent decision-making.

References

[1] Barber, Brad M., Terrance Odean. "Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors." The Journal of Finance, vol. 52, no. 1, 1997, pp. 127-160., https://faculty.haas.berkeley.edu/odean/papers%20current%20versions/individual_investor_performance_final.pdf [2] "Backtesting: A Primer for Algorithmic Trading." Investopedia, investopedia.com, 2020, https://www.investopedia.com/articles/active-trading/101014/basics-algorithmic-trading-concepts-and-examples.asp [3] Markowicz, Michael. "Why Algorithmic Trading Can Be Dangerous." The Motley Fool, 2022, https://medium.datadriveninvestor.com/how-to-predict-stock-movements-the-motley-fool-effect-a541ec1ce609 [4] Adrian, Tilman, et al. "Algorithmic Trading and Market Microstructure." Bank for Int