The Pros and Cons of Using a Robot to Trade the Forex Market

The lure of trading using a robot sounds too good to be true. Imagine if trading was as easy as finding the right piece of software to magically turn out money into more significant amounts for minimal risk. And therein lies the rub. Risk is the key factor when trading a robot. Over time, many robots will be right more than they are wrong. The question that you should ask yourself before you start to invest money in a systematic robotic software that trades the forex market is what type of risk you are willing to take. For example, are you willing to risk making 100% of your money if you first might lose 30%?

Could you expose yourself to a significant drawdown despite your belief in the robot's success? There are many pros and cons to using a robot to trade the forex market. Before delving into the benefits and drawbacks, it is helpful to understand what forex trading is and what kinds of robots best serve the market.

What is Forex Trading

Before understanding the pros and cons of using robots to trade the forex market, it will be helpful to understand what is forex trading. The forex market is considered an asset class that allows investors to benefit from changes in the exchange rate of currency pairs. An exchange rate is a ratio used to determine the volume of one currency that will be exchanged for another. Forex exchange rates change activity throughout the day, 24 hours a day, six days a week. The forex market is the largest of the capital markets, with more than 7.5 trillion dollars changing hands every day.

The most prominent players in the forex arena are commercial and investment banks. These financial institutions are part of the interbank market. With this space, banks and some of their large clients exchange currency pairs which provide liquidity to corporate treasuries, central banks, hedge funds, mutual funds, and trading houses.

You can trade within the forex market in two distinct ways. The spot market is the most active and liquid. The spot rate used in the spot market requires delivery of the currency within two business days. If you want to trade the forex market with delivery beyond two business days, you must execute a trade in the forward market. Any three business days and beyond is considered a forward trade.

To calculate the forward rate of a currency pair, you add forward points to the spot rate. The forward points of a currency pair are calculated using the interest rate difference between two counties (or regions') short-term interest rates.

The currency pairs that are the most liquid and have the most activity are the major currency pair. There are six major currencies that all trade against the Dollar to be considered a major currency pair. The currencies include the Euro, the Japanese Yen, the British Pound, the Swiss Franc, the Australian Dollar, and the Canadian Dollar.

Trading Forex using a Robotic System

Now that the forex market has been explained, we will discuss trading the forex market using a robot.

A systematic robot is a system that follows specific rules to generate trades and calculate risk management. The rules are generally based on technical analysis, allowing the user to define specific rules to create a transaction. For example, when the 5-day moving average crosses above the 20-day moving average could be criteria that a trend-following system uses to capture short-term movements in the forex market.

The trip of using a robot is to define your risk. Each robot will use different criteria to generate an offset trading signal. You want to have a keen understanding of the risk management that is used when you pick out a systematic robot. If the risk management is a specific percentage of each trade, then you know the most you will lose is approximately the stop loss percentage.

What is a Stop Loss

Your risk management might be a stop loss, that exits a position when the amount of your loss is a specific percent change in an exchange rate. For example, if your stop loss is 2% when the exchange rate moves from 100 to 98, you would exit your currency position with a stop loss order. Stop loss orders can be accomplished whether you are long and selling a position or short and covering a position.

Alternatively, if your risk management is based on a reverse signal and not a fixed percentage, your take-profit levels will be variable. A variable stop loss might make money, but the returns can be volatile. Remember, the returns you receive will be based on the reward you are willing to accept.

If you plan to make a lot, you need to be willing to lose a lot. If you want to make a certain percentage, you should understand that you can lose that percentage.

The Timing of Using a Robot

Robots, like markets, can outperform over certain periods and underperform. While on average, the robot might be successful, it might have losses for months to years, and they have spectacular gains. The timing of your entry and the robot's performance over time is important. If the robust consistently make money every month, and you can verify the information, you have found yourself a winner. If the robot has consecutive months of winners followed by consecutive months of losing returns, your timing for using the robot is critical. You might not be willing to accept a 30% drawdown with the hope of a 100% return if it's not guaranteed. 

Backtesting

It's important to gauge what type of returns a robot has produced. Not only do you want to see it over a long period, but you also want to see each period. The analysis of how well a robot performs is called backtesting. Most robots are created by seeing how well the robot performed using historical data. The robot might have done well in the past, but you want to know if it performed well each year or if there were years or periods when it underperformed. You want to ensure that in 5 out of 10 years, the robot did well, and in 5 years, it did very poorly. You also want to see if the robot has a track record using real money. When a robot only worked well for a specific period, the robot was created fitting a curve to work during a particular period.

So What are the Pros and Cons of Trading Forex using a Robotic System

One of the benefits of forex trading using a robot is that the process takes a lot of the emotion out of your trading activities. Instead of wondering whether you should enter or exit every momentum, you can rely on the robot to generate buy and sell signals.

You don't have to sit around and watch the market or even be an expert in each currency pair to trade a robot. You can determine if the criteria meet your risk profile and decide if that meets your goals and the potential risk versus reward ratio expected by the system.

One of the negative aspects of using a robot is that the risk profit might not meet your criteria. You might be looking for a specific return based on fixed losses. Many robots have variable risk management styles. For example, a trend-following strategy might profit from a signal reversal. If the system is always in the market and buying and selling based on signals, you can experience a significant drawdown.

The timing of your entry is essential as you might catch the market when the robot is underperforming.

You might find that the robot "fits a curve" but does not work well in periods other than the backtest period. 

The Bottom Line

The upshot is that there are several pros and cons related to trading the forex market using a robotic system. System trading is not suitable for everyone, especially those who might not trust technical analysis. The system uses specific criteria to find trading opportunities that have worked. The past results do not guarantee future earnings.

As events change, market conditions change, so a trading system will need to change. Based on past price movements, trading systems might fall short of capturing specific periods. If you are unwilling to see if the system works in the future, you are taking the systematic approach away from a robot.

If you are willing to live with the pros and cons of trading the forex market using a robot, you might be able to successfully find a system that reflects your trading style and availability.

Disclaimer : The above is a sponsored article and the views expressed are those of the sponsor/author and do not represent the stand and views of The Tribune editorial in any manner.