Using Trading Systems : Why It is a MUST to Understand Their Logic

The paradigm in automated trading seems to tell people new to the market that they must not understand anything or be knowledgeable in trading to achieve success since successful trading strategies can be coded into “expert advisors” which can then be used on their metatrader 4 platform (or another platform that supports automated trading scripts) and make them earn money in the long term. People easily embrace this idea – on top of seeming reasonable – the thought of being able to get profits from trading without “moving a finger” is extremely tempting. However the reality in mechanical trading – particularly when automated trading systems are involved – is extremely different and failure often follows those who do not understand the logic behind their trading systems. On today’s post I will show you why understanding the logic of the systems you are using is NOT optional when dealing with automated trading and I will show you some clear examples of what happens when people neglect to understand the core of the system they are trading. In the end you will see that trading a so called “black box” is extremely unsound and a decision that will ultimately put you at a disadvantage and cause you to lose money in forex trading.

What is wrong with the assumption that simply executing a script will yield you profit ? As a matter of fact there is nothing wrong with this and there is ample proof that mechanical strategies can provide profit for people in the long term. The problem here comes when you consider that you have to choose the strategy you want to run and survive through draw down periods in order to actually get to that long term profitability goal. If you lack an understanding about a trading strategy’s logic you will have no idea of what it does and in what implicit danger it puts your account each time it takes a trade. Since you will be ignorant about the way the system enters and exits trades you will be unaware of the long term consequences this might have or the unreliability it may place on simulations. For example a strategy can be coded to look at future bars in the backtester in Metatrader 4, in such a case someone could come up with an extremely profitable strategy in simulations and sell it to you as a black box. It is clear that if you knew that the strategy does this you would have never bought it but since you don’t know the logic within it, it is impossible for you to know.

There are other cases – the most dangerous ones – when a strategy shows very good long term simulations, profitable live trading results and therefore it seems like a very good strategy to purchase. However a study of the strategy’s logic clearly shows that the system uses an unsound trading tactic that will – eventually and inevitably – lead to the total loss of the account. Such was the case with the Robominer trading system. People bought this expert advisor with great hope after good 4-5 year backtests and 6 month live tests showed that the EA could make “steady profits” without ever reaching an extremely high draw down level. This EA used a grid trading strategy based on the flawed assumption that the EUR/CHF and the AUD/NZD remained under tight long term ranges. Of course, basing any system on a fundamental assumption of absolute price values will inevitably make it fail, something that becomes clear to any knowledgeable trader who analyses a system’s logic.

However, ignorant about the system’s inherent characteristics and the implicit risk determined by its logic many people started trading this system with absolutely horrendous results. In the long term the EUR/CHF reached lower and lower and lower levels while the AUD/NZD also reached far above its high historical levels, proving that this strategy is inherently flawed by design. I know people who lost from 1K to 200K using Robominer and all this was a consequence of an inherent lack of understanding of the trading strategy since the actual information about it was made freely available by the developer.

Cases such as that of Robominer clearly show us that “knowing” the trading strategy a system uses is no way to guarantee success and that live and back testing information is NOT enough to show convincingly that a system can remain profitable in the longer term. Ultimately an understanding of the system’s trading strategy is needed so that a full interpretation of the back and live testing statements as well as a full assessment of the risks incurred by the trading system can be taken into account. Evidence of performance does not mean anything if there is an inherent lack of understanding behind it since systems that postpone risk have the ability to show profitability for even prolonged periods of time, later crushing accounts with their unlimited risk potential. In order to choose automated trading systems and use them successfully in the long term a person needs to know what the strategy does – and most importantly – understand the consequences of these trading tactics and the risk in which they put capital in the long term.

In the end – as I pointed out a few times – success in automated trading is bound to be even harder than success in manual trading because a much deeper understanding of the market is needed. Not only does a trader need to understand how the market “works” and how money management is designed and implemented but an in-depth understanding of coding, simulations and the long term analysis of strategies needs to be achieved. If you want to succeed in trading with mechanical strategies then the understanding of the systems you are trading and the logic behind them – how they enter/exit the market and how they decide how much money to risk – is essential for your long term survival. If you are unwilling to do the effort to actually make this happen then it is highly likely that someone who does put up the effort to reach a higher level of understanding will take your place as a profitable automated trader using mechanical trading strategies.

We can see then why it is so hard to achieve success using automated trading strategies, not only do we have to figure out how to trade but we also need to deeply understand the strategies we use in order to avoid using strategies that “seem good” but that ultimately lead our accounts to total wipe outs. If you would like to learn more about automated trading and how you can gain a true education in this field please consider joining, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach to automated trading in general . I hope you enjoyed this article ! :o)

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