How to Beat A Futures Trading Algorithm
Written by Steven Speck | Edited by Brian Cullen
To many people, the idea of an algorithm – especially in the context of trading, might as well be describing the foundational elements of calculus or maybe even the guiding principles of general relativity. In essence, an algorithm seems as an incomprehensible system that is only able to be understood by a very few group of experts who have a dominate advantage to all other market participants because they can create these “undefeatable” systems.
Now, maybe you don’t hold such an intense pessimistic view of competition against Algorithms. Maybe they’re not “undefeatable” in your mind, or not even in the realm of super abstraction but rather something you just don’t fully understand. Regardless of where you fall along the spectrum of understanding Algorithms, they are playing an ever increasing role in all types of trading and for that matter all of daily life.
What is a Trading Algorithm?
So what is a trading algorithm? Honestly, an algorithm is just a set of instructions. In our context, it’s a set of instructions on when to buy and when to sell. The instructions are put together based off of “desired” technical market indications on when to enter a market and when to exit a market. Say the writer of the algorithm puts together a poor set of instructions then the algorithm will perform poorly. If the writer of the algorithm puts together a good set of instructions then the algorithm will perform well. Below is a very basic example of instructions which could be the steps of an algorithm.
This example runs into some problems, like what happens if there is no contents in the pitcher? If your desired result was to say pour a certain amount of water out of the pitcher into another container then there are a few steps that should be added to ensure a correct result. These steps would include adding confirmation that there is water in the pitcher at the beginning, aiming the pour, the height the pitcher is being picked up and so on. Every time there is a step added to the system the system could become more accurate in accomplishing the desired result. There is a drawback to adding steps to the system which is the more steps you add the longer and more computation it takes to perform. If the algorithm (system of steps) is too long, then it might not be able to be executed fast enough to be effective.
To address efficiency and effectiveness from a computer science perspective there are many different logic (math) approaches that can be employed. For a basic approach at explaining algorithms check out Khan Academy through this link. For a more complex look at algorithm analysis from a computer science and coding perspective check out this link.
The Advantage of Using A Trading Algorithm
In my analysis, algorithms have one outright advantage over humans when it comes to trading. Since algorithms in our context are run by computers they have no emotion. They simply complete the system of steps their creator gave them with 100% disregard to their interpreted success, for to a computer completing the systems of steps is the success. If the computer places a “bad” trade (negative emotion evoked in humans) that loses money it doesn’t know/understand it. The computer will continue to trade the system until told to stop. On the flip side if the computer places a “good” trade (positive emotion evoked in humans) that gains money it also doesn’t know/understand it and will continue to trade the systems steps until told to stop. For this reason computer run algorithms have an outright advantage over humans.
Many people which include financial professionals would throw into this argument that computer algorithms can enter and exit trades much faster than humans which is true. Speed in trading is often an advantage but not in all cases. There are times that moving too fast can cause missed opportunity, over execution, or the incurring of loss. It is these reasons that I do not include speed as an outright advantage of computer operated algorithms.
Can You Beat An Algorithm?
Yes, people can out trade a computer run algorithm to have better gains. The reason it isn’t often heard of is simple. People are very emotional and lose discipline (don’t stay consistent with their plan) when their emotions are evoked whether they are positive emotions (adding on to a winning long positions when your indicators tell you to sell and take a profit) or negative (resorting to guessing at trades when you have placed a few losing trades).
Don’t believe me? Let’s go back to the beginning of the article and review the question, what is a trading algorithm? It’s just a set of instructions, which in the modern trading world, are laid out for computers to read and execute the same over and over without the existence of emotion. If you want to beat the computer algorithms come up with a better set of reliable instructions that you can implement on a timeframe that works for you. Once you’ve done that stick to your plan, if it needs revision over time then you can update it.
Can we humans out trade a computer run algorithm? The answer is yes, it is very possible to out trade a computer run algorithm in the sense of participating in the same market and still realizing a profit. If you seriously want to be successful in trading or anything for that matter you must learn how to manage your emotions so that when they are brought out, you can stay disciplined and not lose sight of your ultimate goal.
Khan Academy. (2018). Intro to algorithms. [Video file]. Retrieved from: https://www.khanacademy.org/computing/computer-science/algorithms/intro-to-algorithms/v/what-are-algorithms
Shruti, Tanwar. (March 28, 2018). Let’s simplify algorithm complexities. Retrieved from https://medium.freecodecamp.org/lets-simplify-algorithm-complexities-25e75f37d03f
For a more in-depth look at computer algorithms I will be writing an article to cover that topic in the future. To see that article or others like it please check back into the Daniels Trading website frequently. Until then, I encourage you to look over the many resources Daniels Trading provides with access to even more resources to those who open and fund an account.
Subscribe to The Cullen Outlook Product SUITE
The Cullen Outlook Product SUITE - The Cullen Outlook is for those wishing to follow the moves of a technical trader. You’ll get to look over the shoulder of a senior futures market strategist, see the market set-ups that grab his attention, and learn what he looks for when analyzing a chart!
The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.
Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.
© 2021 StoneX Group Inc. All Rights Reserved