3 Big Warning Signs To Watch For When Choosing An EA (VIDEO)
Hi, this is Shaun Overton with ForexNews.com and OneStepRemoved.com. In this five minute video, I’m going to share the 4 biggest warning signs to consider before using an expert advisor in your live account. I always recommend demo trading new EAs before risking live funds. If you don’t currently have an MT4 demo account, OANDA offers them for free. You can sign up for one using the link underneath this video.
Register for a free OANDA MT4 demo account here.
I always recommend demo trading new EAs before risking live funds. If you don’t currently have an MT4 demo account, OANDA offers them for free. You can sign up for one using the link underneath this video.
Every trader wants to win all the time. It’s only natural. But, you need to watch out for expert advisors that have an extremely high percentage of winning trades. I know that sounds crazy. It’s true.
The example I give new traders is this question: “If I had an expert advisor that makes $1 on every trade and it wins 99% of the time, would you want my EA?”
Almost everyone says yes. The best response would be to ask me, “how much does it lose on the 1% of losing trades?”
If you make $1 ninety-nine times, the total value of winners after 100 trades is $99. What you’ll often find is that these EAs with high percentage winners have catastrophic losses. If that one loss in 100 trades is more than $99, it’s a terrible idea to run the system.
Because of some basic statistical properties, it’s possible for an ultra-high percentage winning EA to show hundreds of winning trades without any major losses. However, when the devastating loss does happen, it frequently wipes out all of the gains… and some of your original trading capital, too.
You’ll never know these devastating losses are possible just from the trading history. The only warning sign is when the percentage of winners seems extraordinarily favorable.
Another indication is the relationship between the stop loss and take profit. Say that an EA uses a take profit of 3 pips and a stop loss of 100 pips. You don’t have to be good at math to expect an EA like that to experience large streaks of winners.
If your expert advisor doesn’t use a stop loss, the best proxy to use is the ratio between “average winner” and “average loser”. Those statistics are available on any MetaTrader performance report.
When losses do come around – and it’s a certain fact that they will, they’re devastating to the point where they wipe out all of the wins.
Most traders mistakenly assume that winning consistently equates to profiting in the long run. Not so. I’ve worked in the forex industry for 8 years. It’s my experience that strategies with such lopsided reward risk ratios are usually weak signals. Loading the strategy to exit for quick profits is usually a technique to cover up poor long term performance.
The second pitfall is the most dangerous one to avoid. It’s called the Martingale strategy and it comes from the world of gambling.
Martingale proposes the idea that a loss is never final. Whenever a loss occurs, the Martingale method calls for doubling the risk of the next trade to recover previous losses.
The idea appeals to traders in an extreme way because it requires absolutely no skill to trade.
The critical flaw in the concept is that it also requires an infinite bankroll. Doubling the risk means that your account equity decreases at an exponential rate as the losses accrue.
It only takes a single losing streak to wipe out the entire account. I’ve spoken with countless traders that followed Martingale for various periods of time. They make money for anywhere from 3-9 months. Then, one day, it’s all over. The account balance is zero.
I worked with a trader a few weeks ago that followed a Martingale system. Every day he made anywhere from a few hundred dollars to $3,000. His account equity stood at over half a million dollars after 9 months.
Then one day, he had several losing trades as a the market reacted to major news. His positions fluctuated wildly, hemorrhaging money from the account. By the time he decided to pull the plug, he literally had nothing left.
Can you imagine how that feels to have $500,000 one day and $0 the next? It’s emotionally devestating. Even though the event is several years behind him, he still talks about it with raw pain and emotion.
I’ve heard people counter, “What if I just trade until I made X and then stop?” There are several reasons why that’s a terribly idea:
There’s no guarantee that you’ll hit $X in the first place. You can still blow up and lose the account.
Even if you do hit $X, you’re not going to stop. I’ve worked with thousands of traders in my career, many of whom practiced Martingale. I’ve never met anyone – not a single person – that stopped before their account blew up. The temptation to run the system “just one more day” is too intense.
It’s a fun ride while it lasts, but the outcome is always the same. You will lose in the long run if you trade a Martingale EA. Don’t do it.
Lastly, people choose expert advisors to trade based on characteristics instead of long term performance. They find an EA that entertains them in the short run with quick, high risk profits. Those types of strategies almost always fall apart.
I’m specifically referencing scalpers. If you’re not familiar with the concept, scalping is an extremely short term trading strategy that attempts to take a large number of small winners. It usually involves holding a open trade for anywhere from a few seconds to several minutes, but no longer.
Every trade costs money in the form of the bid-ask spread. All platforms have spreads – OANDA’s spreads are some of the lowest of the major platforms. A typical spread on the OANDA platform for EURUSD is 0.9 pips. When you trade a mini lot, that’s $0.90 that immediately leaves your account. It’s a cost.
The cost of the spread is the same whether you’re scalping or trading based off of 4 hour charts. If a scalper shoots for 3 pips of profit, the 0.9 pip spread is 30% of the expected profit. If a position trader shoots for 100 pips of profit, the typical spread is less than 1% of the expected profit. The impact of spread costs on short term trading strategies is more than thirty times higher than a position trader.
Hopefully, that gives you an overview of the top 3 warning signs to look out for when evaluating expert advisors. When you’re ready to try out an EA in a demo account, you can get a free demo account from OANDA by clicking the link under this video.