How to employ the use of EAs to boost your risk management strategy
How to employ the use of EAs to boost your risk management strategy
Risk management is probably one of the most important skills in trading the markets, but a trader’s mentality is what ultimately dictates the execution of proper risk management. The Expert Advisors eliminate the psychological factor when it comes to trading and as such, makes risk management the most important benefit of developing an EA.
“You got to risk it to get the biscuit”. Following the advice in this adage in trading would surely destroy any trading system. In Forex, risk management is the process of identifying, quantifying, and managing a strategy’s risk exposure. Risk management is an insurance of your investment like medical coverage is an insurance of your health. Bad risk management is perhaps the most common pitfall for failing as a forex trader, because people tend to overtrade and take on positions; larger than their equity can handle. Capital preservation should be more of a focus than capital appreciation.
The ultimate goal of trading and investing is to make money but without taking uncomfortable levels of risk. The most important job is that of a risk manager. Before you open a position in forex, you must first assess the associated risk. Calculate the pips difference for your stop loss and then set a take profit. Only after doing so can you decide if the position is really worth it.
When you create an expert advisor you should make sure that you apply strict risk management control. You should always set a stop loss and have a backup plan for the worst case scenario. You can set up a stop loss based on percentage in your EA as well.
One of the reasons why developing an Expert Advisor is complicated; is that the traders who devise the logic, have not the slightest idea what risk management really is or how it can be used to one’s advantage in algorithmic trading. Every system will eventually have losing streaks but as for the when they will come and how long they will last, no one can be certain. It goes without saying that if you wish to succeed in trading; you have to be prepared to endure through these losing streaks.
There are five possible outcomes of a trade - a big profit, a small profit, a breakeven trade, a small loss and a big loss. What you must avoid at all costs; is the large losses.
A good mindset to avoid the big losses is illustrated below:
IF I LOSE I NEED TO MAKE
20% 25% (To break even)
50% 100% (To break even)
The most important component of risk management is the position sizing. With Expert Advisors you have the ability to perform back-testing, to evaluate your strategy, based on historical data. The resulting values which you can glean from back-testing, like the “Maximum Drawdowns” and “Biggest losing trades”, are especially valuable in improving your EA and preparing for the real markets. It is highly recommended to conduct back-testing on long timeframes of more than 7 years (to test all market cycles if possible) with different position sizing to observe the reaction of your system with different leverage ratios. On your EA you can determine the position size based on your account’s balance.
With rigorous back-testing over long periods of time, you can greatly enhance the risk exposure of your system, because it will reveal all the weaknesses in your strategy. Through back-testing you can gather and identify the reasons behind the big losses and boost your risk management defenses.
Granted, oftentimes it’s good to deactivate the EA due to unknown market conditions and due to high risk events that usually inject the market with high doses of volatility. These events can be a central bank’s announcement, a conference or even state elections. It is very important to stay out of the market on these days because of the unpredictability that greatly increases the possibility to blow out your account.
In a nutshell, losses are part of the game. Eliminate the big losses and what you are left with is a solid strategy and that’s what risk management is all about.
Written By Yiannis Georgiou, Head of Reception and Execution Departments, at Forex Time
Disclaimer: The content in this article comprises personal opinions and ideas and should not be construed as containing personal and/or other investment advice and/or an offer of and/or solicitation for any transactions in financial instruments and/or a guarantee and/or prediction of future performance. ForexTime Ltd, its affiliates, agents, directors, officers or employees do not guarantee the accuracy, validity, timeliness or completeness of any information or data made available and assume no liability as to any loss arising from any investment based on the same.
Risk Warning: There is a high level of risk involved with trading leveraged products such as forex and CFDs. You should not risk more than you can afford to lose, it is possible that you may lose more than your initial investment. You should not trade unless you fully understand the true extent of your exposure to the risk of loss. When trading, you must always take into consideration your level of experience. If the risks involved seem unclear to you, please seek independent financial advice.
Past performance is no guarantee of future returns. An investment involves the risk of loss as well as the potential for gaining.
NOTES TO EDITORS
The FXTM brand name was founded by Andrey Dashin in December 2012. FXTM provides access to the global currency market and offers trading in forex, precious metals, Share CFDs, ETF CFDs and CFDs on Commodity Futures. Trading is available via MT4 and MT5 platforms with spreads starting from just 0.5 on the Standard MT4 trading platform and from 0.1 on the ECN.MT4 and ECN.MT5 trading platforms. Bespoke trading support and services are provided based on each client’s needs and ambitions – from novices, to experienced traders and institutional investors. The brand name is registered under various jurisdictions, one of which is regulated by the Cyprus Securities and Exchange Commission (CySEC), whereby FXTM is registered under license number 185/12.
