Do robo advisors work in trading?Forex is a risk management exercise

1. The original strategy ran on equities daily bars with no leverage. Forex runs at higher frequency (30, 15 or 5mn). At daily bars level, the market has time to digest information. Signals are not so noisy. At higher frequency, the noise to signal ratio detetiorates significantly. Patterns do not form well.

   With crushingly high leverage (100:1 and above), mistakes are costly. So, the game is to minimise drawdowns when strategy stops working and capitalise on the winners. The only way to do this is to develop an adaptive position sizing that will collapse risk in drawdowns and re-accelerate thereafter. We have developed a convex position sizing dll.

   2. Time is the wrong container

   Robots are designed to run on time charts. Now, volume is not constant throughout the day. Markets don’t trade much in the middle of the night but they are active between Europe and US open.

   Our robot would detect valid signals during liquid hours and false positives during low volume hours. Time is the wrong container. BTW, this is the same reason flash crashes happen. Poorly designed algos treat low and high volumes uniformly.

   Our solution has been to use constant volume charts. A big Thanks to Scott Phillipsfor introducing me to tick charts.

   3. Forex is not a Christmas tree of indicators, moving averages, Fibo

   Many traders use multiple indicators, oscillators. Charts end up looking like Christmas tree. This junk is redundant, fragile. Complexity is a form of laziness.

   We use sophisticatedly simple rules that use onTick price only, no lagging derivative of it.

   4. How to handle false positives and the science of stop loss

   The shorter the periodicity, the noisier the market. Compounding effect of false positives + high frequency = rapid erosion of the equity curve. Stop losses are costly. So, the game is about avoiding stop losses and managing false positives.

   These are thorny signal, stop loss and position handling issues. In fact, whatever the problem, better entry is rarely the right solution. We have developed three solutions:

   1. scale out to reduce risk as early as possible. This comes from my experience as a short seller. First priority after entry is to reduce size/risk so as to mitigate upcoming short squeeze
   2. French stop loss: markets are noisy. Patterns develop over time. So, we give enough wiggle room to each position to fully develop. stop loss is fashionably late, hence its name: French stop loss. The flip side is smaller position size
   3. Multiple time frames: traders who look at multiple time frames want to use longer trends. We have found an inventive way to spot significant longer trends not by using different time frames, but point of significance within a single time frame
   4. Time is a form of asset allocation: sometimes price goes sideways. Looking at different time frames, either short and/or longer, there are perfectly valid trends. So, the same strategy can be deployed across various time frames so as to hedge or supplement the pivot time frame

   5. Philosophy, beliefs and concepts

   At the end of the day, an automated strategy is the extreme formalisation of a philosophy. Complexity is a form of laziness. Every challenge required changing perspective, unlearning, simplification. This is the hardest and never ending part. Apple’s iOS will never be finished, and neither will our forex strategy.

   In China, women usd to have their feet wrapped in banadage so as to make them petite. It is said that every centimeter was worth a barrel of tears. Every month on the strategy has brought its own barrel of tears.

   Over the last two years, I have eaten enough humble pie to open an international bakery chain. It has been a long painful journey of unlearning and purification of concepts to their essence. If i had known beforehand what i was up for, i would have looked for a job in the HF world. This is much more cushy than designing a Forex robot

   Conclusion

   Going in, i thought the strategy i used to run was sophisticated. Now in retrospect, it seems crude, blunt disrespectful of the markets. You must respect the markets for one reason only, because markets certainly will not respect You back.

   Forex robots work, but they are incredibly hard to design and complicated to program bug-free.

   Ironically, it is easy to develop the skills to assess robustness of autotrade strategies. Rather than trying to program your own robot, i would focus on analysis existing ones. Calculate a weekly (if available) monthly:

   1. Common Sense Ratio to assess robustness amidst drawdowns
   2. Performance/Ulcer Index to determine the quality of performance
   3. ask about position sizing and Voila

   Now, the above paragraphs may discourage any aspiring strategist. Here is the greatest lesson of all: building an automated investing is like building a timepiece. Until the last cog fits in, time will be off. It will be one hell of a tourbillon but persevere, don’t give up.

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