Using an algorithm to trade, also known as robot trading, uses a systematic approach to make a decision. A robot will make entry, exit, and risk management decisions for you based on several criteria.
While robots are an automatic way of making trading decisions, they are only as good as the criteria used to make the decisions. There are several pitfalls associated with using a robot to make trading decisions.
These bumps in the road include the data that is used to backtest the robot as well as the risk management criteria used to create the trading decisions. Several securities can be used to trade capital markets using a robot. Contracts for differences is a popular instrument used for those who trade using a systematic approach.
What is CFD Robot Trading?
Robot trading is a systematic approach to trading. Generally, when the term “robot” is used, it refers to an algorithm that generates buy and sell signals. Several types of securities can be used to trade using a robot, including CFD trading. A robot will test a strategy using historical data to determine if the trading strategy worked in the past.
The robot programmer will try several different types of criteria and then use the input that works the best. Algorithm trading can be used to design short-term scalping strategies and long-term trend-following strategies.
Before you use a robot to trade the CFD market, you’ll want to make sure that you test the robot yourself and see if it works in real-time. Several robots will work on a demonstration account where you can avoid risking your capital to determine if the algorithm performs the advertised way.
Building versus Buying a Robot
If you decide that you want to use an algorithm to trade the CFD market, you have two choices. You can use either program it yourself, or you can purchase a robot. When you program an algorithm, you can use several systems that are geared to help you backtest historical data. Backtesting is determining if a strategy has worked in the past.
You can program a system yourself to see if a set of criteria has worked, or you can use a system that might have a graphical user interface that will allow you to point and click to design your system.
One of the benefits of developing your system is knowing the criteria that are used to create the plan. For example, this can be programmed if you want to risk $1 for every $4 you gain as potential profit.
The risk management system within each systematic algorithm is a critical piece of information. If you purchase a robot, it is challenging to determine the risk management criteria used to evaluate the algorithm.
The System is as Good as the Data
Another issue you might face when you are building or using a robot is that the system is only as good as the data used to create the robot. If the data is inaccurate, your result will also be incorrect. Before backtesting data, you want to sift through the data yourself to determine if any results might be false.
If you purchase a robot, you might assume that the programmer examined the data before testing the criteria, but this scenario is not guaranteed. The term “garbage in, garbage out” refers to an algorithm’s results if incorrect data is used to backtest a system.
If it’s Too Good to be True
When backtesting your robot, you should assume that if something is too good to be true, there might be an issue with the data or the criteria. For example, if you are only using daily data, you need to understand that without using high and low points, your risk management criteria will not capture intra-day issues.
If your stop-loss criteria are based on daily closes, there can be intra-day moves that would generally require that you exit your position that will not be captured when you backtest your algorithm. An alternative approach is to use intra-day data for backtesting your algorithm.
You also want to avoid backtesting on a small subset of data. This process is called curve fitting, where you mistakenly test on a short period, during which the system works, and do not test multiple periods to see if your criteria work over many periods.
The Issues with a Purchased Robot
One of the issues with purchasing a robot is that you are generally not privy to the criteria used to create the robot. You are also unsure if the data is cleaned and works appropriately across many types of securities. In the best circumstances, testing the robot on a demonstration account will be helpful before you purchase the robot.
A demonstration account is an account that allows you to use a platform without using real capital to trade. Many reputable brokers provide clients with demonstration capital to enable them to test drive their platform.
By using a demonstration account, you can see if the robot will work on the platform you use for CFD trading. If you see that the robot works on the CFD trading platform, you can plan to employ them.
The Bottom Line
Before you begin CFD trading with a robot, you want to make sure that you determine whether it meets your expectations. If you program the algorithm, you can be assured that the system will work as you set your criteria (however, this does not guarantee any specific result of the trade).
If you purchase a robot, you should consider using a demonstration account to determine if the robot works as expected. You also want to ensure that the data you use to program your robot is robust and does not have errors. You also want to test whether your robot works over multiple periods to ensure you do not curve-fit your algorithms.