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How to Find an Edge for an Algo-Trading System?

How to Find an Edge for an Algo-Trading System?

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As we mentioned in a recent post, there are several advantages to building your own automated trading system. One of the advantages of using a trading strategy that you have developed yourself is the fact that you will have an edge for longer. Of course, that’s assuming your algo-trading system has an edge to start with.

While automated trading software makes it very easy to automate a trading strategy, unless the strategy has an edge, it will not be profitable.

Before you can build a profitable system, you need to find a repeating pattern that you can exploit – preferably one that not many people know about. Here are a few ways to find that edge.

If you spend a lot of time watching a particular in instrument, be it a currency pair, stock or index, you will probably begin to notice certain patterns repeating. These patterns are always worth further exploration to see if the pattern really exists and if it’s possible to exploit it.

A more deliberate method is to start with a very simple trading system and explore the signals it generates in detail. It doesn’t even need to be a profitable strategy – just a simple system using no more than two indicators that generates at least 100 signals for every 3,000 bars or so.

Once you have a list of signals you can start deciding which of them could potentially have been profitable, and which were unlikely to have been losers. At this stage you shouldn’t be concerned with exit strategies – you just want a rough idea of whether a trade could have been profitable or not. It doesn’t matter if most of them are losing trades either, but it helps if you can have a sample with at least 50 winning trades.

Now it’s time to look for similarities between the winning trades and similarities between the losing trades. It’s a good idea to use a wide variety of indicators that will give you an idea of patterns in volatility, volume, trading range and trend. The more creative you can be, the more chance you will have of finding unique patterns.

Automated trading software allows you to automate this part of the process, but it’s also a good idea to observe manually by looking at each signal and the type of trading environment that preceded it.

You can also look at the chart on a higher and lower timeframe to get a sense of the conditions that preceded winning and losing signals. Don’t forget to take note of the time of day and day of the week of each signal, and whether there was news flow before and after each signal. Plotting the signals on the chart for another instrument might also provide clues as to the conditions that preceded winning trades.

It’s also worth looking at the losing trades and seeing if they could have been faded. The objective is not to optimise the original system but to find pattern that you can use to build a new system with an edge.

Conclusion
You can use this process again and again, starting with different trading systems, on different timeframes and for different instruments. You are more likely to find a real edge by following a manual process like this than by using automated trading software to optimise an inferior system.

This approach can be used for algo-trading, manual and even discretionary trading. Even if a pattern is not suitable for an automated system, you may be able to create an EA to use for discretionary trading.

If you want to automate your forex trading strategy feel free to contact us. Nordman Algorithms specializes in MQL4/MQL5 programming services, developing EAs and Custom Indicators for MetaTrader 4 and MetaTrader 5 trading platforms. All you need is an idea and we can give you a time estimate and quote to turn it into a MT4/MT5 expert advisor or MT4/MT5 indicator.

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