Software is eating the world.
It has been an entire decade since venture capitalist Marc Andreessen made that statement. Nowadays, algorithms are threatening to replace many workers, but not everyone is against that change.
Forex trading is hard work. It takes a lot of time, energy and mental fortitude. Some traders look to forex robots as a solution that will take that burden off their shoulders.
Read on to find out what forex robots are and what to look out for if you consider using (or building) one.
What is Forex?
Foreign exchange (or forex) is a decentralized global market for currencies.
As the world shifted toward floating currency rates in the 1970s, the forex market grew as a result of rising globalization.
Nowadays, it works through a network of banks and other financial institutions. It is an over-the-counter (OTC) market with each transaction closed between the parties. Aside from derivatives, it is by far the largest market in the world, with a daily volume of over $6 trillion. It operates 24 hours a day, 5 days a week.
Which Currencies are Available to Forex Traders?
Currency pairs are usually in 3 groups:
- Majors: Dollar crosses and the most traded currencies globally like EUR/USD, USD/JPY, USD/CHF, GBP/USD, AUD/USD, USD/CAD and NZD/USD.
- Minors: Less popular pairs that don’t include the U.S. dollar. These are EUR/JPY, EUR/GBP, GBP/CHF, GBP/JPY and others.
- Exotics: Crosses between a major currency and a currency of a developing economy. An example includes EUR/TRY, USD/HKD, NZD/SGD and many others.
Benefits of Forex Trading
Forex has advantages over other asset classes. The top 4 reasons why you should consider trading forex are:
- Available 24/5: Forex market is open 5 days a week. It kicks off with Australia opening on Sunday evening and it ends with the U.S. close on Friday. During that time, there is always an open exchange somewhere in the world.
- Highly liquid: The forex market offers unparalleled liquidity. Because it facilitates global trade, its volume exceeds $6 trillion per day. This means that trade size will never be a problem — a major advantage over some other asset classes, like penny stocks.
- Cheap to trade: Because of high liquidity, forex spreads are reasonably low. This is especially true during the times of day when the U.S. sessions and European sessions overlap.
- Easy to understand: Exchanging currencies is a concept that is very easy to understand. You are simply shifting from one currency to the other as you believe it will gain in value.
What is a Forex Bot?
Forex bot is an automated trading program that generates and executes trading signals based on predetermined parameters.
Forex robots also are known as expert advisers (EA), as this is the term of reference with the most popular forex trading software MetaTrader 4. While there are fully automated robots, semiautomated robots will notify but not execute any trades.
There are 2 significant advantages that a robot has over humans. The 1st is time, as it can observe the market 24/5, never taking a break.
The 2nd is speed. A computer can do the calculations exponentially faster and follow numerous forex pairs at the same time.
Unfortunately, most forex bots are unprofitable over a long time. They might offer good testimonials and data samples, but the key lies in the data-mining bias and curve fitting.
In other words, just because you have tossed a coin 10 times and got 10 heads, doesn’t mean your coin-tossing skills are extraordinary. There is a statistical probability that might occur, and on a large enough sample, it will.
Many of the bots that look great haven’t been appropriately tested in different market conditions. They might prove promising in the short term but ultimately lead to disappointment.
How to Choose the Best Forex Bot
Choosing a good forex bot is not much different from choosing a robust, nondiscretionary trading system — as algorithmic trading is nondiscretionary.
In the book “Beyond Technical Analysis,” Tushar Chande argues that a sound system should follow these parameters:
- Positive expectation: The goal of the system is to make money.
- A small number of robust trading rules: Preferably, there are 10 rules or less for entry and exit.
- Applicable to multiple markets or different forex pairs: Rules should be sound enough to work in a variety of conditions.
- Incorporates reasonable risk control: Risk (drawdown) should not be more than 20% and last more than 9 months.
- Fully mechanical: The system should not be ambiguous. The rules should be clear and nondiscretionary.
What to Look for in a Forex Bot
Evaluating a forex bot requires a good sample size and attention to detail. There are many parameters to watch out for, including profitability measures and risk measures.
Below are some of the essential parameters.
- Net profit: The difference between gross profit and gross loss. The 1st goal is to have a positive net profit.
- Profit factor: The absolute value of the ratio of gross profit to gross loss. It shows profitability per $1 of loss.
- Percent profitable: Shows the percentage of profitable trades. However, a figure above 50% doesn’t mean the system is profitable.
- Average trade net profit: It’s the average profit received per trade.
- Outlier-adjusted profit to loss: A profit factor adjusted for the most significant profits. This helps smooth the results by taking out possible outliers that might skew the results.
- The annualized rate of return: It helps benchmark against the market returns.
- Payoff ratio: It’s the ratio of average winning trade to an average losing trade.
- Length of the average winning trade to average losing trade: It measures whether the system holds losses for too long (if the ratio is below 1).
- Efficiency factor: It’s the net profit divided by the gross profit. A good system usually has 38% to 69% — the higher, the better.
- Maximum drawdown: The maximum loss from an equity peak. Generally, one should expect a maximum drawdown twice as large as found in backtesting.
- Recovery ratio: Net profit percent as a ratio to maximum drawdown. It measures the return per unit of risk.
- Maximum consecutive losses: The number of losses in a row. If this number is large, it mandates further investigation as it often affects the maximum drawdown.
- Longest flat time: This shows the longest period where the money is not in use.
- Time to recovery: It measures how long it takes to recuperate the losses. Ideally, it should be short.
- Sortino ratio: Measures risk-adjusted returns. It is similar to the popular Sharpe ratio but only considers downside volatility. It is calculated as the ratio of the monthly expected return minus the risk-free rate (for example, treasury bills) to the standard deviation of negative returns.
Best Forex Brokers
Trading forex is hard without brokers. These specialized intermediaries help you invest in currencies at a low cost through web platforms, desktop platforms or even your phone. Check out the list of Benzinga’s recommended brokers in the table below.
Let the Buyer Beware
Any time someone offers to sell you a money-making machine, you should be questioning their motives. The forex market offers great liquidity, and scalability is hardly a problem for fully automated systems.
Yet hope can be addictive and cloud judgment. While forex veterans usually recognize these perils, they can be a costly lesson for inexperienced traders.
For them, the best decision will always be to master manual trading first.
Frequently Asked Questions
Forex bots are legal — there is no breaking the law in automated trading. However, some brokers might not allow them. This might be for different reasons, but it is usually connected to high-frequency trading and its constraints on the broker’s platform.
It highly depends on who is using them and, more importantly, why?
A majority of turnkey forex bots won’t make money in the long term. Given the depth and insane scalability of the forex markets, it makes little sense to sell or rent a money-making machine — you would be much better off just using it yourself. Inexperienced traders who plan only to use the bot stand a little chance of beating the market.
On the other hand, experienced traders who have been trading for a long time often use tested strategies and sound risk management. Developing a bot using that experience likely won’t be as good as manual trading, but it might help make more money in the long run. After all, nobody can follow the market 24 hours per day — except for a machine.
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