In This Episode
- Is an automated trading system your way out of psychological torture?
- Why you should separate your data when backtesting
- Kevin Davey book
- When to throw a trading strategy away
Is Automated Trading Really “Emotion Free?”
Many traders are attracted to trading robots because they think that they can just sit back and let the profits roll in.
There is also the desire to not have to go through the emotional rollercoaster that trading can take new traders through.
But is that realistic?
Is automated trading really free of all emotions.
In this episode, we talk about the realities of creating trading robots and why they might not be as great as you think they are.
Read the Transcript:
Hugh: Hi, Walter. This is something that came up recently this week. It is about mechanical back testing or automated strategies. What is the kind of psychology you go through when you test something that is automated? It can be difficult for the average trader to get into EA or some sort of a program. Stick it in. They test three or four pairs and it does not work. So where would you take it from there?
Walter: So, probably I would recommend to people who were into this, there’s a couple of books. One is by Kevin Davey and the other one, it's by another guy. I'll put the links in the show notes.
Here’s to deal with that like you really need to group your data into two sets. One set is the set that you are going to test on and make sure that your strategy works. Which is what you are talking about. The other set which is the out of data, out of set data that you are going to use to take that system that you’ve developed and see if it actually works.
So, in one sense here you are like, let’s say, you have some moving averages and bollinger bands and RSI. You are kind of optimizing the levels and the values and all that on one set of data. Now, what you need to do is take that data and out of a sample of data is where you actually run the strategy to see if it works.
That is really important because a lot of times what people do is they will take like, if they have sixty months of data, they will take like fifty-five months. Develop a strategy and then take five months to actually test it. You do not want to do that. You’re actually better off in the reverse. Having a little chunk of time or data to develop a strategy and then more to actually see if it works.
That is why I am a real big believer in simple strategies that do not have a lot of degrees of freedom. So degrees of freedom just means the availability of different settings, different levels. So, the moving average has tons of degrees of freedom.
If in that case what you said, which is if I had a strategy and I tested on it, it did not work, you should probably throw it away. That would be the thing to do but in most cases, what people do is they’ll go back and say, “What if I’ve done this?” What’s happening now is you are over optimizing that data set. Immediately, as soon as you did that.
As soon as you said, “Okay, I am going to use this indicator” or this pattern or whatever it is, on this set of data and it didn’t work, that’s like throwing it away. Start with something completely different because the more you go back on that set of data and try to make it work, the more what you’re doing is feeding that strategy to work on that particular set of data. Do you know what I mean?
That time period in the market and that will come out when you take that data and then you apply that system. That system that you’ve used, that you’ve developed on that set of data and then apply on the out of sample data. So that is the real problem.
Probably the biggest thing I think is that. It’s understanding the relationship between the data that you’ve used to develop your strategy and the data that you’ve used to test your strategy. The other thing is, a lot of traders think that automated trading is the be-all-and-end-all and it’s your way out of psychological torture as a trader. That is not true.
Hugh: Exactly.
Walter: That is not true. It is not true because you still have to turn it on and you have to turn it off. You have to say, “Oh no, we’re in the GFC. We’re in a pandemic so that means I should not trade my strategy or I should reduce my risk”. Basically, what you are doing is you are making up rules on the fly because you do not have any contingencies for that when you developed your strategy.
So thinking that letting the computer make the choices for you is going to help you avoid the psychological pitfalls of trading is, I think, wrong. I don’t think that is true at all. Unfortunately, a lot of us fall victim to that. Now, I will admit that I do like to use automation on the exits. I found this to be very freeing.
If you are using a trailing exit or something that you do not want to check every, for me, I do not want to check every six hours or eight-hour candle or whatever. So, I can do that. I can set a target and I can set my automated EA exit to get me out. So that is really cool I think.
There is still a temptation to fiddle with it and all that but at the end of the day, using automation in your trading is really kind of a test to how developed or revolved you are as a trader I think. The more confidence you have in your automation, whatever that is, whether an exit rule or the complete strategy, that is going to come from your testing, from your experience, from getting dirty with the data.
If you are a beginner, and you are starting to get into trading, I think that is the worst thing that you can do. I really do. I think you are better off just learning simple strategies and applying them manually but I think later on it kind of is, the way that a lot of traders end up looking.
If you have been doing this for ten years, you will certainly look for some short cuts. You are going to look for something like, “How do I get myself away from the computer” sort of thing. To me, I can see those two things: the in sample and out of sample testing and a thought that it is going to remove all emotions from your trading.
I think those are two biggies for me. What about you?
Hugh: That is true. I mean, I’ve never been a big fully automated person either but I can see where either automating the entry or the exit could be a good way to go and just kind of saves yourself some time. My trading buddy likes to automate his entries so that the stop gets moved automatically but he manages the exit.
You automate the exit so, I can see that it’s helping there but I think the idea of testing or having a fully automated system is not for everybody. I think the psychology behind that and the technical mindset behind that is really hard to get your head around.
Hugh: Hey there! I hope you find this episode useful. I just want to let you know that Walter and I give away something valuable every month that helps traders improve their skills. You can enter to win by simply leaving an iTunes review and leaving a comment on our YouTube videos.
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Walter: To be honest I think people over complicate it. The degrees of freedom thing like seriously I’ve seen some really good strategies and you know what they are? They’re things like buy the Pound at three o’clock everyday.
It is like simple stuff like that and you are like, “What? That would never work” or buy when the market or sell when the market makes three candles in a row where it closes higher than the previous candle. You kind of like counter trend move or whatever. You look at the rules of the code and you are just like, “No way! There’s no way that is going to work” but it does and so that is another thing to keep in mind.
I think as beginners, we start like that. Now it is the same way. My friend and I, my trading buddy, have a spreadsheet with fifteen different things. Different indicator levels that we look at and I would actually tick on the spreadsheet yes-no, yes-no then if I have like twelve or fifteen in the right direction, I would take the trade. That is what I did and I was on the three-minute charts.
Do you know what happened? By the time I went through all fifteen things, the three-minute candle was already printed. Do you know what I mean? It was crazy.
Hugh: I think we’ve been down that route before with the checklist.
Walter: Yeah, it was so funny.
Hugh: Cool. Thanks for the insights.
Walter: Alright, thanks.
Hugh: All the information in this podcast is for educational and informational purposes only and is not trading or investment advice.
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