Forex Robots: The Good, The Bad and The Ugly! Part 1

Contributed by: Trading School (http://ino.com) -

As forex continues to explode I asked a good friend, Dr. Jeff Wilde from AskJeffWilde.com, to bring us his expert opinions. As the title states he’ll be bringing the good, the bad, and the ugly! He’s also asked for personal stories (of good, bad, or ugly) to be left in the comments!

==================================================================

Unless you haven’t turned your computer on over the past 12 months you can’t help but notice that practically every week another forex robot comes on the market. My inbox is getting bombarded with offers lately all promising me a life of riches with little or no losses by using these forex robots. Anyway… I am blowing the lid off of the robots and taking an in depth look at them. I have a lot to say about that and will get to it in a moment.

I pretty sure most everyone reading this knows what a forex robot is but for you newbies let me explain briefly…

A forex robot is a computer run program that is designed to analysis the forex markets for trade setups based on a particular trading system. Whats more they can easily analyze multiple currency pairs at the same time. In addition they will automatically place the trades for you without you even having to be present. The most popular forex software to use forex robots with is Meta Trader.

The GOOD things about robots are…

1. Save a lot of time
2. Prevent you from having to do a lot of manual analysis on your charts
3. Eliminates user error
4. They can even place the trades for you automatically.
5. They can easily trade multiple markets in real time. This is something very hard for a great many traders.
6. Allows you to be doing something else while it trades for you.
7. Allows traders with minimal experience to start trading very quickly.
8. Helps remove user emotions and indecision

Now for the BAD…

For starters…

1. What happens if your computer crashes while the robot has you in a trade? Unless it is able to put all its commands onto your forex brokers server, you could be screwed.

2. You need to realize that a forex robot is not magic. It is simply a set of trading rules designed by a human being. And, the system is only as good as the person that created it.

3. There is a lot of “smoke and mirrors” in the wold forex robots. What I am talking about is the use of a thing called optimization. This is a feature that allows you to go back in time and analyze all the trades your system would have taken and then what it does is … It will change the parameters of the system to improve the results. For example say your system uses a 8 period and 21 period moving average crossover as one of the triggers for a trade. Well when the software goes through the optimization process and it will examine hundreds of moving average combination’s and determine which would have provided the best performance. Lets dig a bit deeper…

A little optimization is ok as it may help you discover a better combination of indicators then you could have come up with on your own, but…

The big problem is when the robot creator gets carried away with the optimization process, because they can literally keep tweaking things until they show little or no losses on the test results.
The trouble with this is that the robot creator is doing a thing called “curve fitting” the results. This gives a false sense of security and can be very misleading as a curve fitted robot will ALWAYS eventually fall apart in the real world. This is one of the reasons you see some of the forex robots boasting extraordinary profits fall apart within days or weeks of using them.

Now for the UGLY…

1. A lot of the new forex robot systems are claiming no losses. Now I have to say this as clearly as possible, that is BULL S*&#! Yes they may show no losses but there are some dangerous things going on. The systems that say no losses don’t use stop losses. Their reasoning is that eventually the trade will close out profitably. Well maybe many of the trades will, but what happens if just one doesn’t?

I was evaluating a robot the other day that claimed 100% wins. Well guess what? It was sitting on a GBP/USD trade that had an open loss of over 500 pips. Sure its not a loser until you sell it, but who wants to see a trade down that many pips? To give this a different view, look at investors who bought a stock for say $200 a share back in 2000 and now it is trading at $2. Technically they don’t have a real loss until they sell it, but the bottom-line is their account is down huge. And it could take 20 years for the stock to come back to break-even, if it does at all.

So back to forex… What happens if something happens on the GBP/USD that forever devalues it? It means that the 500 pip loss could keep growing and never comeback to break even. What then? That one trade could wipe out your account.

2. Other forex robot systems claim very high win rates of over 90%. That is great until you dig deeper and read the actual trade reports. What you will see is something like this… Nine trades will make small profits like 5 pips – 10 pips and then all of a sudden it gets a big loser of 50 to 100 pips. In one trade all the previous gains are wiped out and you have to start again.

3. Another form of robots have truly impressive gains when you look at their back tested results. You will see that they made say 457% over the past year. The trouble is when you look at a thing called the equity drawdown, the account could have dipped down in value as much as 75%. Now I don’t know about you, but most traders can’s stomach that kind of draw down.

Let me wrap this article by giving you a real world, real money example of a robot. Two years ago a friend of mine had developed a robot to trade the emini futures markets. Over the past 6 years it had averaged 92% winning trades and never had more than one losing trade in a row. It also produced huge returns each year. My friend had traded it for a year and it performed with real money exactly as it had done over the past 6 years. So far so good…

I told him I wanted to open an account and I started with $15,000. In just 3 weeks the account was up to $35,000 and at that rate I was sure I was going to be a millionaire within a year! Well out of nowhere it had 2 losses in a row and they were big. In the blink of the eye the account had dropped to $20,000. I was blown away at how it could fall apart and have 2 losses when they hadn’t occurred in over 700 trades in the past 6 years. At this point, my friend said something wasn’t right and that we should be really careful from here on in. Fortunately I pulled the plug on the system and closed the account because the system had a 3rd loss in a row the next day. According to all back tests this was mathematically impossible, but that didn’t stop it from happening.

In hindsight we have no idea why the system fell apart, but what I do know is that its fatal flaw was that the losing trades were 8X-10X bigger than the winning trades. That’s how it got the 92% winners. It may be obvious to you that the risk to reward values were really bad, but…

This is generally how forex robots can claim few losing trades. The reality in trading is that it is almost impossible to create a trading system that has a 90% plus win rate with A small risk and huge reward ratio. If it does exist, no one will sell it to you for $97 because it it could easily be sold to a financial firm for tens of millions of dollars.

Anyway… I have a lot more to say on forex robots. This is just to get you thinking and to open your eyes because there are some really crazy claims being made out there. I’m not anti-forex robots. but there is a whole lot to know and learn in order to make them work in your favor.

Dr. Jeff

To read Part 2 please visit AskJeffWilde.com