Be the Brain not the Tool: My Attitude on EAs

Be the Brain not the Tool: My Attitude towards EAs

Abstract

This article summed up my attitude towards trading with Expert Advisors, known as EAs in short. EAs are trading robots that execute trades according to a preset formula. My attitude is that trading is a game of accumilation of small edges in probability, and whatever that increases my number of edges are welcome. I think that EA can increase my edges as long as: a) I understand the mechanism behind it, and b) it allows sound money management, in particular mulitple entries and exits. I am also againt the common attitude towards the use of EAs, which consists of treating them as Holy Grail and using them before acquiring proper manual trading skills and experience.

Introduction

I'm never a keen tester or reviewer of Expert Advisors. For those who don't know, Expert Advisors (EAs) are automated trading programmes which are executable on the popular platform of MetaTrader 4 (MT4). In others words, they can make trades for you when you are not at the computer, or "make money while you sleep" as it's been advertised by vendors.

On online forums, I seldom join the discussions and much less the testing of various EAs. It's not that I don't like EAs, but I don't like the way they are discussed. I say this because their discussion has nothing to do with making you trading more profitable, and instead it is more like reporting news of a celebrity in auotmated trading.

Be the casino: how I view trading

Before going further, I would like to write a paragraph or two to describe my philsophy on trading.

For me, trading is a game of probability, you win the game by beating the odds. Think about it like the casino. The casino has set the rules in a way that the long term probability is already in its favour, so that although customers have occasional big winnings, in the long run they can benefit. The same is and should be the mindset of a trader.

The casino has various ways to increase its edge of probability. They have great resources for catching cheaters. They don't have clocks in the hall so that you easily forget the time and keep playing, and the more you play the greater chance you lose. They limit your time to think and plan. The list goes on. Similarly in trading, whatever that increases your edge should be taken into account, that will include sound money management, emotional control, finding an honest broker, etc.

In all, trading is a game of probability, the aim is to increase your likelihood of winning and not to take unnecessary chances.

How EAs increase your edges

Can EAs increase your edges? Certainly. Robots don't have emotions, they always follow the plan. They never get tired, you don't have to worry about oversights. They are automatic, and quick to enter, modify and exit positions. Most importantly, you don't have to be present in front of the computer.

The problem is, EAs have their problems too. They are based on sets of hard rules, i.e. they are simply following orders. The problem of how to trade is to be decided by the trader. It's like telling a taxi driver to drive me to the place I want when I do not have a car with me, but going to that place should be my own decision. Similarly, I can tell my EA to enter a trade today at 8-10 am EST when the 5 and 13 EMAs cross and 10 period RSI crosses 50, but why I have to do it today at this time, not yesterday, not another time, comes from my experience with the system.

Why don't I just let the EA run by its own course? Because the EA itself does not know when to trade and when not to trade. To put it more scientificly, the EA had no idea when the system has a high probability of winning and when the system has less chances. If you just let an EA to run by itself and it encouters a time when the market does not suit the system, you are going to lose. As I said above, trading is about increasing your probability of winning, and just blindly let your EA run is not a way of doing it.

Therefore, to increase the probability of winning with an EA, one has to gain a good understanding of the system employed by the EA. In fact, a good EA is usually coded from a manual method traded by the coder himself or someone the coder knows. M5G Cyborg is one such example. When the coder knows a system inside out not just in theory but also in practical experience, he is more likely to be able to increase its strength and cover its weakness. This is similar for a trader. Only by having experience with the system behind it, we can predict with confidence how probable the EA will make money in certain conditions.

The Only Holy Grail: Money Management

There is no Holy Grail system in trading. There are only systems that gain more than lose in the long run. For this to happen, one must make sure he can stay long enough in the game so that the probability is on his side. The only way to do this is: don't lose too much in one trade.

If there has to be one thing that, if done, can guarantee you success, then I can't think of anything except good money management. Instead of going through a tedious lecture of how great money management is, I am going to tell you a real story that happens online.

Colin McGinley was the first runner-up of the 2007 FX Trader of the Year competition in FXStreet in which he gained 35.3%. He actually finished third originally but the winner were caught cheating. Anyway, he kept his trading record in 2007-2008 in this post in his blog, and this is what he said there:

"Up until August 2007 my monthly target return was always in the 3-5% range. In August 2007 I decided to become slightly more aggressive and began to target a return of 7-10% a month.
I became more aggressive in two ways. The first was to increase my gearing on individual trades by 50% as compared to what I had been using previously.

"Secondly, I started trading on additional pairs. I added USD-JPY first and have recently also added AUD-USD.

"In retrospect, mainly due to the larger than desired unrealised drawdown in November 2007, I have decided to cut my gearing back to its original levels. I will continue to look for the additional monthly gains through trading on multiple currency pairs."

So, he almost blew his account that month by losing almost 80% of his capital.

If an EA allows smart money management by the user, then it is no doubt this is a great edge in increasing the probability of winning. Many EAs have already got the function of auto position sizing, so it's no big deal. Money management, however, is not just about risking only 5-10% of your capital. One of the most important technique in money management, in my opinion, is scaling in and out of a position. One thing I really look for in an EA, but most of the time I can't find, is the option of averging an entry and exit.

Averging an entry means that instead of entering the whole position one time, you instead enter it bit by bit. My favourite example is that, you first enter 2/3 of the position, and after the price moves (say) 10 pips away from the original entry, either in favour of or against you, you enter the rest 1/3. Anyone with experience in trading knows that you cannot always enter and then the price goes in your direction. By averging in you are able to reduce the risk of entering at the wrong time.

The concept is similar for averaging an exit. These are very mechanical thing the requires precise timing, and it is better done by a computer. Remember I talked about one edge that EAs can give you is fast execution? Whatever that increases your edge should be done, and whatever things that EAs can do better than you should be left to them.

How the crowd discuss EAs

Now you may understand why I don't like the way people discuss EAs, espeically commercial "black box" systems. They look at how great the past performance it has, not worrying whether they are genuine or not. They don't care about what systems does the EA really contains. All they worry about is tweaking it with different settings, testing it in different brokers, and give out graphs and numbers about their newest findings.

There are nothing wrong with such practice, and quite the contrary I apprecaite people spending their free time in contributing to the society. However, as I said above, the only way to let an EA work for you is to have hand-on experience with the system or systems behind it. The problem of the common practice of EA testing is twofold. Firstly, they don't try to understand the system behind it. Secondly, they do not go back to the graph and actually study why a trade failed. Of course, not all testers are like that, you can find testers who have a healthy understanding of trading, but most of the time the testers are some people who haven't even made a trade in a live account ever in their lives.

Furthermore, I feel that most tester in online forums are simply too lazy to worry about possible failure of their Holy Grail EA. They are mesmerized by the beautiful backtest results and then they start to dream about becoming a millionaire someday, instead planning what to do if their EA somehow fails to work in the future. What will you do if your trusted EA start losing money? Do you judge it as occasional loses or market condition changes? Will you stop using it, and if so for how long? How can you tell when it is time to start using it again?

Once again you see the importance of becoming familiar with the system behind it. If you do, you may already switch off the EA before it loses money. If you all know is that the EA gives out buy and sell arrow, what can you do about it? This is why you should not treat any EA or system as a Holy Grail, and you should understand the system behind the EA.

Conclusion

I always think that EAs, or any indicator or scripts for that matter, are only the tools of trading. Whether they are profitable or on depends on how they are used. Most people are slaves to EAs: when things don't work out well, they imprision themselves in front of the computer to try various different settings in vain. A good trader, on the other hand, should be the brain before any trade and only use the EA to help him carry out the plan. This can only be done by acquiring a thorough understanding of the system behind the EA and exercise proper money management.