Regular income with automated trading
Even when you got a profitable strategy, like one of Zorro's Z systems, it's not trivial to squeeze a regular income out of it. The markets go through periods of different efficiency and cause a high fluctuation of trade results. Systems that generate a relatively safe income are mostly based on mid-term or long-term strategies, but can still suffer long drawdown periods of several months, even up to a year. Drawdowns are no strategy flaw, but a logical and mathematical consequence of profitable long-term trading.
Admittedly, a 12-month drawdown does not sound well suited for a regular income. But there's a simple trick to overcome drawdown periods: Do not rely on one single trading algorithm and one single asset. With many uncorrelated algorithms and assets, a drawdown on one combination is cancelled by a win series on another - at least in theory. In reality, you'll find that many assets are more or less correlated, either positively or negatively. Still, a combination of different assets and trade algorithms gives you the relatively steady profit curves that you can see from Zorro's included Z strategies.
Seven rules for earning money with automated trading
- Have enough capital. The minimum capital for a modest regular income is in the $5000 range. The free Zorro version limits your account size to $7000 (see restrictions), but you need not all your capital in the broker account - you can keep it in a savings account and remargin when your equity drops dangerously low. Have at least twice the required capital from the performance report at your disposal. Most brokers support fast depositing funds by credit card in a few minutes.
- Know your broker's trading platform. You should be able to observe and manually close trades anytime in case of an emergency, ideally from your mobile phone. If a trade was not correctly opened or closed due to a software glitch - this happens rarely, but it can happen - know how to deal with the problem. If it was a glitch of the broker's server or software, know how to contact the broker and request a refund. If it was a bug in Zorro or in your script, you'll get our compassion, but no refund.
- Know your strategy. You should understand how it basically works and what risk and performance you can expect. Test it under different spread and margin settings to avoid nasty surprises. Never trade with systems based on algorithms that you don't know or understand.
- Pull out in time. Examine the trading results regularly and compare them with the test performance. If you start losing too much money, don't hesitate and stop the strategy. There is likely something wrong. The strategy might be expired due to a change of the market, or it was not profitable at all due to a biased backtest.
How much money is "too much"? The simplest way is comparing the loss with the required capital - when you lose more, you've exceeded the normalized drawdown and should stop. A more precise estimate is the following formula: E = C + P*t/y - D*sqrt((t+l)/y). E is the expected minimum equity, C is your initial capital (= the Required Capital of the simulation), P is the test profit, t is the trade time, y the test period, D the test drawdown, and l the drawdown length. Example: the test shows $8,000 profit after 5 years with a $2000 1-year drawdown, and $1500 recommended capital. You invest it and are down to $1000 after 6 months. E = 1500 + 8000*0.5/5 - 2000*sqrt(1.5/5) = $1204. You're below minimum profit. Pull the plug.
A more precise algorithm for pulling out or not is described under "The Cold Blood Index" on the Financial Hacker blog.
- Do not pull out early. The equity curves of all systems are subject to fluctuations that are normally larger than the upwards trend (see chart below). That's why the Total down time of successful strategies can be in the 90% range, and that's why at some point after starting a strategy you'll be almost always below your initial capital - otherwise you would need no capital at all!. If you stop the strategy just at the first drawdown, the money is gone. This is a frequent mistake of beginners to automated trading, and results in losing money even with highly profitable strategies. Be prepared for fluctuations and drawdowns as bad and long as in the backtest: they will really happen, and they can happen anytime and right at the begin. A streak of 20 successive losses with real money is admittedly a special experience; grit your teeth and sit it out - at least when the backtest suggests that such a streak can happen.
- Do not tamper with the strategy. It's hard to see profits dwindle in a drawdown, but the strategy is already optimized. Any manual intervention will only make it worse. For the same reason, don't often stop and re-start strategies: this closes open trades, initializes any intermediate parameters the strategy might use, sets back the lookback period, and thus more or less reduces the performance dependent on the strategy. Any manual closing of trades can cost several hundred pips and can convert a winning strategy in a losing one - no matter if those trades were in the profit zone or not. For 'soft stopping' a strategy without loss, set the margin to zero so that no new trades are opened, then wait until the strategy itself has closed all open trades.
- Do not get greedy. When your profits accumulate, you'll be tempted to increase the margin. This will of course also increase drawdowns. But the average drawdown size and duration increases anyway with the square root of the trading time. So you'll need to put aside a part of the profit for compensating this effect, and can not reinvest it. Raising the margin too fast is the second-most frequent mistake of beginners to automated trading, and can wipe out any account regardless of the strategy performance. Avoid increasing the margin proportionally to your equity, as most beginners to trading tend to do. For every doubling of your equity, raise the margin only by a factor 1.4, not by a factor 2. For the same reason, do not withdraw all your profits, but keep a part on your account - look under money management for details.
Typical live equity curve of an automated trading system (Zorro Z5). Note the equity fluctuations and the negative peaks during the first weeks due to the increasing number of open trades. Although the system is steadily winning, pulling out at any initial equity downpeak would end up with a loss. It takes about 8 weeks until enough profit is accumulated for keeping the equity curve safely above zero. Other systems have even higher equity fluctuations and longer drawdown periods.
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