5 Algo Trading Pitfalls
For many investors, the world of alternative investments, specifically commodities and futures, provides an excellent opportunity for enhanced returns and diversification.
Many, however, are put off by the high management fees (typically 2% of assets per annum) and high profit incentive fees (20% or more of profits) charged by Commodity Trading Advisors and hedge funds. And many investments are only open to high net worth individuals. As a consequence, many people look to develop trading systems themselves or use trading signal services.
The do-it-yourself route is popular with investors but unfortunately it is much more difficult than it first appears. While many software platforms make backtesting (testing a strategy using historic data) and optimization easy, only the uninformed would actually utilize a trading system developed in that manner. Developing a trading system the correct way is very involved and should only be attempted by experienced traders.
For many, that leaves trading signal services as the best remaining alternative.
Trading signal services and systems are a means by which the average investor can participate in futures and commodities without having to spend years learning the markets or how to trade them. Signals can automatically be tied into a trading account so that the signals are effortlessly executed, or the signals can be e-mailed to the subscriber, allowing the user to make the final trade decision.
Two of the more popular services include www.striker.com, and www.collective2.com. I have personal experience with each. I can't recommend any other signal services.
Unfortunately, there are many pitfalls to using these services, and subscriber mistakes can easily turn an otherwise winning approach into a losing endeavor.
Below are the 5 major pitfalls that are most commonly experienced by the uninitiated, and how you can avoid falling into them.
1) Subscribing At A Peak
Many people will diligently search through a database of signal systems and simply pick one with the best recent performance.
Many times the best looking systems are at new equity highs and the logical conclusion is that performance of the system will continue at the same pace as past performance.
Unfortunately, this is almost NEVER true.
New equity peaks are invariably followed by drawdowns. So someone investing at a new equity high is almost guaranteed to be met with a dip in performance shortly after jumping onboard.
How to Avoid this Pitfall: Consider trading a new system only when the system is in a drawdown. If past performance holds, new equity highs should happen soon and you may not have to endure a large drawdown at the outset.
2) Picking The Wrong Developer
Signal services are typically run by established companies, but the signals themselves may be generated by a professional trader, a part time trader, or even a non-trading charlatan living in his parent’s basement.
If the signal provider hasn’t been vetted by the signal service, it’s sensible for the potential subscriber to do their own due diligence before subscribing.
Ask questions such as…
How To Avoid This Pitfall: Make sure you know the signal developer’s background and history. This will help you determine if the developer is the right person to be sending you signals.
3) Quitting Based On Personal Preference, Instead Of System History
While having a quitting point (a point where you stop trading the system) is excellent practice, most people select a quitting point that does not fit the system.
For example, many people will stop trading a signal system after a 10% drawdown. That is fine, unless the historic performance of the system shows that 10% drawdowns are common. In such instances, that 10% becomes a surefire number for failure.
How To Avoid This Pitfall: Establish a quitting point that is based on the historical performance of the system. If 10% drawdowns are commonplace, perhaps the quitting point should be at a drawdown of 20-30% or more.
4) Being Too Impatient
Anytime an investor subscribes to a new signal service, fear and anxiety are part of the game. If the signal does not generate immediate positive returns, many subscribers give up, and then jump onboard a different “high flying” system.
Of course, when the replacement signal system underperforms, the subscriber then jumps to the next system. In this way, the subscriber is constantly chasing performance, and likely losing money in the process.
An investor can actually trade all winning systems and still lose money overall!
How To Avoid This Pitfall: Stick with a new signal system for at least 6 months, or until the previously determined quitting point is reached. Give the new system a chance to prove itself before giving up and switching to another system.
5) Falling For Tricks
Some signal providers tout meaningless numbers, such as a 90-100% winning percentage. Watch out when you see something overly enticing, since it may be a trick.
For example, many signal providers with high winning percentages increase their position as a trade goes against them, otherwise known as “adding to losers” or “averaging down.” This can lead to huge open losses during a trade – temporary losses that will never show up in a closed trade list.
The developer, of course, hopes the trade eventually turns around enough to be claimed as a winning trade. Unfortunately, most subscribers would not be able to endure the drawdown involved in such schemes, and would exit the trade at a loss.
How To Avoid This Pitfall: Examine the trade history carefully. Look for suspicious behavior, such as adding to losers. Avoid any developers that sometimes appear to trade in a way that enhances their winning percentage or inflates other meaningless statistics.
***
Subscribing to a signal service can be profitable when handled correctly. But it can be equally unprofitable if the subscriber makes bad decisions. By avoiding the above 5 pitfalls the trader has a much better chance of experiencing success.
Many, however, are put off by the high management fees (typically 2% of assets per annum) and high profit incentive fees (20% or more of profits) charged by Commodity Trading Advisors and hedge funds. And many investments are only open to high net worth individuals. As a consequence, many people look to develop trading systems themselves or use trading signal services.
The do-it-yourself route is popular with investors but unfortunately it is much more difficult than it first appears. While many software platforms make backtesting (testing a strategy using historic data) and optimization easy, only the uninformed would actually utilize a trading system developed in that manner. Developing a trading system the correct way is very involved and should only be attempted by experienced traders.
For many, that leaves trading signal services as the best remaining alternative.
Trading signal services and systems are a means by which the average investor can participate in futures and commodities without having to spend years learning the markets or how to trade them. Signals can automatically be tied into a trading account so that the signals are effortlessly executed, or the signals can be e-mailed to the subscriber, allowing the user to make the final trade decision.
Two of the more popular services include www.striker.com, and www.collective2.com. I have personal experience with each. I can't recommend any other signal services.
Unfortunately, there are many pitfalls to using these services, and subscriber mistakes can easily turn an otherwise winning approach into a losing endeavor.
Below are the 5 major pitfalls that are most commonly experienced by the uninitiated, and how you can avoid falling into them.
1) Subscribing At A Peak
Many people will diligently search through a database of signal systems and simply pick one with the best recent performance.
Many times the best looking systems are at new equity highs and the logical conclusion is that performance of the system will continue at the same pace as past performance.
Unfortunately, this is almost NEVER true.
New equity peaks are invariably followed by drawdowns. So someone investing at a new equity high is almost guaranteed to be met with a dip in performance shortly after jumping onboard.
How to Avoid this Pitfall: Consider trading a new system only when the system is in a drawdown. If past performance holds, new equity highs should happen soon and you may not have to endure a large drawdown at the outset.
2) Picking The Wrong Developer
Signal services are typically run by established companies, but the signals themselves may be generated by a professional trader, a part time trader, or even a non-trading charlatan living in his parent’s basement.
If the signal provider hasn’t been vetted by the signal service, it’s sensible for the potential subscriber to do their own due diligence before subscribing.
Ask questions such as…
- How long has the signal provider been trading?
- Does the provider trade his own signals?
- How many failed signal systems does the provider have in his past?
How To Avoid This Pitfall: Make sure you know the signal developer’s background and history. This will help you determine if the developer is the right person to be sending you signals.
3) Quitting Based On Personal Preference, Instead Of System History
While having a quitting point (a point where you stop trading the system) is excellent practice, most people select a quitting point that does not fit the system.
For example, many people will stop trading a signal system after a 10% drawdown. That is fine, unless the historic performance of the system shows that 10% drawdowns are common. In such instances, that 10% becomes a surefire number for failure.
How To Avoid This Pitfall: Establish a quitting point that is based on the historical performance of the system. If 10% drawdowns are commonplace, perhaps the quitting point should be at a drawdown of 20-30% or more.
4) Being Too Impatient
Anytime an investor subscribes to a new signal service, fear and anxiety are part of the game. If the signal does not generate immediate positive returns, many subscribers give up, and then jump onboard a different “high flying” system.
Of course, when the replacement signal system underperforms, the subscriber then jumps to the next system. In this way, the subscriber is constantly chasing performance, and likely losing money in the process.
An investor can actually trade all winning systems and still lose money overall!
How To Avoid This Pitfall: Stick with a new signal system for at least 6 months, or until the previously determined quitting point is reached. Give the new system a chance to prove itself before giving up and switching to another system.
5) Falling For Tricks
Some signal providers tout meaningless numbers, such as a 90-100% winning percentage. Watch out when you see something overly enticing, since it may be a trick.
For example, many signal providers with high winning percentages increase their position as a trade goes against them, otherwise known as “adding to losers” or “averaging down.” This can lead to huge open losses during a trade – temporary losses that will never show up in a closed trade list.
The developer, of course, hopes the trade eventually turns around enough to be claimed as a winning trade. Unfortunately, most subscribers would not be able to endure the drawdown involved in such schemes, and would exit the trade at a loss.
How To Avoid This Pitfall: Examine the trade history carefully. Look for suspicious behavior, such as adding to losers. Avoid any developers that sometimes appear to trade in a way that enhances their winning percentage or inflates other meaningless statistics.
***
Subscribing to a signal service can be profitable when handled correctly. But it can be equally unprofitable if the subscriber makes bad decisions. By avoiding the above 5 pitfalls the trader has a much better chance of experiencing success.
About The Author: Kevin Davey is an award winning private futures, forex and commodities trader. He has been trading for over 25 years.Three consecutive years, Kevin achieved over 100% annual returns in a real time, real money, year long trading contest, finishing in first or second place each of those years.
Kevin is the author of the highly acclaimed book "Building Algorithmic Trading Systems: A Trader's Journey From Data Mining to Monte Carlo Simulation to Live Trading" (Wiley 2014). Kevin provides a wealth of trading information at his website: http://www.kjtradingsystems.com
Copyright, Kevin Davey and KJ Trading Systems. All Rights Reserved. Reprint of above article is permitted, as long as the About The Author information is included.
Kevin is the author of the highly acclaimed book "Building Algorithmic Trading Systems: A Trader's Journey From Data Mining to Monte Carlo Simulation to Live Trading" (Wiley 2014). Kevin provides a wealth of trading information at his website: http://www.kjtradingsystems.com
Copyright, Kevin Davey and KJ Trading Systems. All Rights Reserved. Reprint of above article is permitted, as long as the About The Author information is included.