Understanding ‘Black Box’ Trading Systems

[RichardCox 10]

Looking at the name itself, it is clear that ‘Black Box’ trading systems have something of a negative connotation. Generally speaking, this negative reputation is promoted either by those that have never used these tools, or those that have lost money using them (and there are many). This also is because there is some level of superiority often expressed by those who feel that their market analysis is theirs alone, and that any gains made (even when using an accepted chartist approach) are the direct result of their own ‘financial genius.’

 

But, is this an entirely fair assessment? Are there huge differences between ‘Black Boxes’ and many forms of technical analysis that are actively accepted by most of the trading community? Is the average chartist using overbought/oversold indicators really all that different from those that employ trading strategies that are purely automated (completed with entries, exits, profit targets and stop losses)? When we start to ask these questions, it is not as easy to view ‘Black Box’ trading in the same negative light. So, while automated trading systems are by no means a ‘holy grail,’ the fact is that technical analysis is technical analysis, no matter what the source. The actual involvement of the trader is simply a matter of degree.

 

‘Black Box’ Trading Defined

 

Black Box trading is referred to by multiple names. Common phrases include algorithmic trading, system trading, automated trading, or EA trading (using Expert Advisors). It has become clear that this method of trading has risen by leaps and bounds during the last decade, as applicable technology becomes cheaper, faster and more accessible. Not surprisingly, this appeals to the part of the human condition that seeks reward without the requisite effort that is needed to analyze the market on our own.

 

In years past, these tools were available only to the market’s largest players. But the game has changed, and most active traders have some version of these tools ready on their trading stations at all times. So, what are the benefits and drawbacks of these “gooses that lay golden eggs,” and what does this mean for the market trading community as a whole?

Advantages in Trade Automation

 

The initial advantage of trade automation is that there is no need to actively monitor your trading station. This effectively takes all of the “work” out of your regular trading scheduled and gives you time to go about your daily life. This also means that you are prepared to receive signals 24 hours a day, as long as markets are open. Last, automated trading systems have backtesting results that are not present with day-to-day approaches that are based on human impulse and intuition. Data limitations tend to produce trading performances that are less successful.

 

Finding An Automated System

 

There are a few ways traders can find and select a Black Box trading system. The easiest way is to simply use a strategy that was developed by another trader. An example can be found at Best Forex Robot (not an endorsement, just an example). Generally, these sites will have performance statistics, such as maximum drawdown, gains (across different time frames), number of winning trades versus losing trades, average gain/loss per trade, etc. Whether or not these statistics are accurate is another story, and this is why it is important to at least test these applications with a demo account before real funds are used. Nobody will ever publish negative results. So, if you ever plan to go down this route, make sure you have an understanding of the methodology being implemented (moving average breaks, momentum, range trading, etc) and do not just buy something with a catchy name.

 

Another option is a social trading community, which have grown vastly in popularity over the last few years. These communities use EAs to allow traders to “mirror” the positions taken by more experienced counterparts. One example can be seen at the MQL5 community, which uses MetaTrader 5 apps and has performance results from a large number of active traders. This approach is similar to using an EA Robot, but has the added advantage of being run by live humans, so it is much easier to ask questions from the traders you follow. It is also possible to become an expert yourself if you have a successful approach that other traders can follow.

 

Last, and most complicated, is the action of devising an automated system of your own. This can be done either through modifying an existing system by changing its parameters. An example could be changing a system that buys upward breaks of a 55-period moving average to a system that buys breaks of a 21-period moving average. In an example like this, your modified system would likely generate more trading signals over shorter periods of time. So, something like this would be less preferable for traders favoring “buy and hold” approaches. This method is best for those with some programming ability and a clear idea of the trading style you want to implement. One example of a site that allows you to customize an EA can be found at FX CodeBase. The site also allows for backtesting and optimization techniques, which we have discussed in a previous article here on TradersLaboratory.

 

The most advanced approach is to build your own strategy “from scratch.” This requires some skill with programming -- but, more importantly, a clear idea of how you want your automated strategy to operate. But if you have been trading using a system that has clear parameters for trade entries, exits, profit targets and stop losses, this might be the best option. Not only are you most familiar with a strategy like this (and you know it meets your needs) but it will allow you to operate around the clock (as long as your trading station is active).

 

Even for traders with no programming skills (just a clear idea of your system parameters), there are developer services that will create your EA for you and make it compatible for your trading station. This, of course, costs more but gives you the added security of having a software app that is stable and reliable. In any case, what is most important is your system itself. Are you a long-term or short-term trader? What is your tolerance for risk? Do you want to base your positions on trend or swing strategies? All of these questions must be answered in order for you to devise your own automated system. If there are more specifics involved in your system, there will be a smaller number of trading signals sent (although those will have higher probabilities for success).

 

Conclusion: Automated Trading Systems Are Not As Uncommon As They Might Seem

 

For those looking to implement an automated, there are many different options that should be considered. Whether you simply want to buy an EA Robot, join a Social Trading Community, Modify an Existing EA, or build one of your own, it is important to start with backtesting and demo trading because this application will eventually be running on its own without you there to monitor it. It is also important to make sure that your system meets your general trading needs. Luckily, there is an immense variety of options available, and finding a strategy that meets your requirements will not be overly difficult for those willing to research a few different sources.

[tradingwizzard 10]

great article, great post.......thanks for sharing