We noticed there has been a great demand for automated trading systems, managed accounts and trade alerts (trading signals) in the Forex and binary options market. The other side of the coin suggests one should learn and trade the markets on his or her own as trading signals and other services are costly and their accuracy level may not justify their usage.
In this article we would like to break down the available services for both the Foreign Exchange market and binary options and assess their quality to the average retail trader, including the ability to recognize a legitimate service and how traders are making poor choices in these services.
Social trading or mirror trading has been gaining popularity in the Forex market and has recently spilled into the binary options market. In social trading, the broker or a firm that is collaborating with various brokers offer any individual traders to compete to become a signal provider.
A signal provider is a trader that the firm or broker lists his or her performance, trades history, instruments and drawdown where the trader with the best performance will be ranked at the top. In order to become a signal provider the trader must submit a track record of a certain amount of closed traders (often between 20- 40 trades).
Upon submitting the account details the algorithm will class the trader in its rankings and will increase or decrease the trader’s rank based on the performance level. Traders may follow countless amount of signal providers and opt for the trader that they believe will generate them a decent revenue.
When you follow a signal provider, every trade the signal provider executes will be automatically executed in your trading account by the firm’s or broker’s algorithm. Every action the signal provider takes will be reflected in your trading account.
The social trading theme has swept many experienced and inexperienced traders, believing that they could now follow the individual with the best performance. There are however many disadvantages for becoming involved in social trading as you will soon discover.
Demo and Live Accounts
In order to become a signal provider, the firm or the broker may not demand a live trading account. That means that virtually anyone with a demo account may issue trading signals and due to the fact the signal provider does not risk his or her capital, losses and a significant drawdown becomes irrelevant. Traders that follow such signal providers are placing themselves in a moderate risk of experiencing hefty losses due to the immense drawdown.
The demo signal provider may have little trading experience but due to a short-lived successful trades or by abusing the firm’s or broker’s algorithm as described in our USDJPY brute force attack article the signal provider was able to increase its rank and benefit from a higher exposure. Traders are then led to believe they have struck gold only to incur hefty losses within a short period of time.
Signal providers with a live trading account tend to be more creditable than demo signal providers, however, the commission model has turned many decent signal providers into generating hefty losses. The signal provider is paid a certain amount from the spread, often in the range of 0.2 – 0.6 pips.
That means every time the signal provider executes a trade he or she will automatically enjoy the commission regardless of the trade’s outcome. To simplify, whether trade was closed with a profit or a loss that signal provider is paid. What is preventing the trader from executing a trade and closing with a minor loss or at the entry in order to benefit from the commission at the expense of his or her traders?
Certain firms attempted to attend this matter by alerting the signal provider that if the month ends without a profit he or she will be unpaid the earned commissions. Unfortunately, such conditions only worsen the matter. A signal provider is likely to over-trade near the end of the month if no profit was made in order to earn the commissions.
Over-trading. which is a well-known psychological dent may lead the signal provider into making irrational decisions that will only increases the losses. On the other hand, if the signal provider is in a profit towards the end of the month he or she may execute a trade and close it with a minor loss such as 2 – 3 pips or with a minor profit in order to increase the commissions.
As the signal provider is paid from the spread of his followers, the more trades that are executed the larger the commissions would be. This of course has a negative effect on the followers that are completely clueless to this risk as the majority of the followers to the best of our knowledge lack real trading experience and a full understanding of the Forex market.
Top Ranked Traders
Even an honest signal provider is not immune to the psychological pressure he or she will face when reaching the top ranks of the social trading performance.
Knowing that followers will leave if the current performance does not leave to their expectations and reading all the negative remarks after a weak month are likely to lead the signal provider into taking greater risks in the market in order to satisfy the followers with a profit, risks that would have been untaken if such a pressure was not involved.
We believe this is one of the reasons why the top 10 traders in many firms are replaced with such a high frequency, which reflects the inconsistency of the top signal providers in the social trading environment.
To show ‘good results’ in order to attract new traders, signal providers noticed that traders only observe their success rate and the accumulated number of pips they have earned. To ‘better’ market themselves, the signal providers tends to use a substantial number of pips for their stop loss orders or not using stop loss orders at all.
Many traders that show over 90% success rate are probably using exaggerated stops or none, which means a significant drawdown. Drawdown is the number of pips the trade went against you regardless of its outcome. Very few traders are paying attention to this detail due to lack of trading experience, only to be mesmerised by the success rate percentage and earned pips.
The Social Trading Business Model
The business model of social trading is also why traders are unable to generate consistent profits by following a signal provider. The firm earns its money by a commission it is charging the brokers that it collaborates with that comes from their traders’ spreads when they execute trades in the market.
By collaborating it means the firm that offers the social trading platform only accepts traders, signal providers or followers from brokers it is working with and that are willing to pay the fee from their trader’s spreads in the market.
Due to the nature of the business model, it is in the firm’s interest the signal providers will generate as many trades as possible as the firm will be paid regardless od the success of its signal providers. We believe the ranking algorithm is favouring scalpers (traders that close a trade with a profit or loss or loss with a small number of pips, which means many trades may be placed on a daily basis) or traders that exceed a certain number of trades per month.
If the firm’s top signal providers are only executing 2 trades a week, even they do manage to profit over +600 pips a month the firm’s profits will be minor unless many traders follow the signal provider. We do not believe any firm will take such a risk as it will be dent its income from the spread, which is why the performance is judged by which signal providers have the highest potential of generating the most income to the firm as well as being successful.
In other words, the firm is most likely to favour scalpers and not swing traders, medium-term or long-term traders. For that reason and the reasons we have mentioned earlier we do not find social or mirror trading to be as fruitful as it appears to be. A better approach would be ‘Watermark,’ which we will discuss later on.
Automated Trading or Expert Advisors
Automated trading via scripts or Expert Advisors (EA’s) as commonly known amongst the MetaTrader4 (MT4) traders appear to be a decent alternative to generating profits from the Forex market. The script or EA is often based on a technical trading strategy that is completely proof to humane emotions.
The EA would execute and close trades based on a predefined strategy and ignores the market fundamentals. Trading with an EA prevents the trader the requirement form observing the market on a daily basis. The trader may continue with his daily chores or ‘lay on the beach’ as some marketers suggest and allow the EA to work its magic.
The first concern with the EA is that many traders do not ask how the EA functions, its market exposure and strategy. Traders must know what is technical reason fro the EA to take a short or a long trade. The market exposure relates to the maximum number of open trades at any given time and maximum leverage that will be used for each individual trade and for all open trades.
The strategy would be whether the EA will act differently when it incurs hefty losses or substantial profits. Certain EA’s will use the Martingale system, which means after a trade was closed in loss the next trade will be twice as big in its size in order to compensate for the less. Such a technique is a decent recipe for a complete disaster.
EA’s that are based on hedging are more complex. The EA must have the ability to calculate the margin requirements once the trade is ‘unhedged’ and determine if the account balance has enough free margin to hold the ‘unhedged’ trade. Certain brokers will demand a margin requirement for a hedged trade.
If you do not check this with the EA provider you are placing yourself in a significant risk of incurring hefty losses from the EA. We have witnessed traders incurring a margin call and then stopped out due to the lack of free margin due to the immense leverage that was used.
Back Testing the EA and Life Span
Back-testing an EA means running the script over the historic data such as EURUSD for example to determine the performance of the EA. During back testing, the EA already knows the open, high, low and close of each session, which is why the back testing performance is not necessarily accurate.
The EA must be tested under live market conditions to determine the EA’s real performance. Ranging markets, volatility and extreme volatility are some of the conditions that must be tested to ensure the smooth functionality of the trading system and its success rate.
There is a well-known saying that if an EA is indeed successful after all the back testing and live testing were concluded, it will stop producing good results within the first three months. This saying is far from being false. The market conditions when the EA was tested may have contributed to its successful performance.
When the market conditions change, the EA may have not been accustomed to such conditions , which will reflect in heavy losses. To prevent this from happening the EA must be tested for a number of years and the EA developer must constantly observe the market to adjust the EA to the market even after years of testing.
Many developers fail in doing this, which is why it is suggested the EA has a life span of three months. The majority of EA developers in the retail market is to focus on generating income from traders that follow their trading system and not on the success of the EA.
There are companies that specialize in algorithmic trading but you are unlikely to come across such EA’s as they are not designed for the retail trading platforms. These EA’s are based on high frequency trading strategies where the aim is to profit over fractions of pips.
The Marketing Procedure
The EA provider may want to show a positive return in the market using his or her EA in order to attract traders follow it. One of the most distinct warning signs is the success rate. Similar to social trading, the EA developer knows that many traders lack the basic understanding of the Forex market will focus on the success rate. If the success rate percentage is over 90% or 100% for that matter something may be wrong.
No technical or fundamental strategy can be profitable on all trades without incurring loss. Such a success rate will often mean foul risk management by not setting stop loss orders or significantly large stops to ensure the trade will close with a profit at all costs.
There was a famous trader that used a 1,000 pips stop and a 20 pips take profit. He was successful for a long time with a huge drawdown but that didn’t prevent traders from following him until one day the stops for his trades were triggered, causing everyone who followed him immense losses. The risk management for an EA that has such a success rate has been meddled with to attract new traders to use the EA.
We have seen EA developers claiming to that their EA has earned them over +1,000 pips a month. This is another cheap marketing attempt to gain followers. In order to boost the EA’s performance, when the EA has an entry it will executes multiple trades in the same direction. For example, assuming there is a successful strategy behind the EA it discovers a long entry in EURUSD.
Instead of executing one trade, the EA executes 10 or 20 (sometimes even more) long trades in EURUSD. Doing so regardless of the outcome of the trade will cause substantial losses if EURUSD does not rise as predicted. Let’s however be positive and say EURUSD rose 10 pips. The EA then closes all the trades and there you have it, 200 pips made as 20 trades were executed and closed with a profit of 10 pips.
If the EA decided to wait for 40 pips that’s 800 pips profit. Such trading is great for marketing the EA but not trading for the long-term. Other EA developers will simply falsify the results of their EA.
If you come across an EA that makes over a thousand pips a month or has over 90% success rate and even over 85% treat it with extreme caution for the reasons we have said above.
Another alarm is the EA developer or managed accounts’ traders promising thousands of dollars to be made in a day, week or month with just $200. Some of you may be amused by this statement but many traders actually think this is real. The only way to turn $200 into $2,000 over a short period of time is to maximize the leverage on each trade. If the trader or EA is successful, $2,000 will be made.
The disturbing matter is that the innocent trader with the $200 is unaware that using such leverage will post a significant risk to his money and that the EA and or managed accounts’ trader is simply gambling with his money. When such leverage is used, if the market trades against you, more than 50% of the invested capital will evaporate in most cases if not all by a margin call. Promises of a high return with a small investment should act as a clear warning to all serious traders.
To conclude, we do not find following EA’s or purchasing EA’s to be suitable for trading in the long-term. Many may disagree with our views on EA’s but our preference is for manual trading where you have more control over your trades in the market.
Managed Accounts, Exploring the Risks
There are multiple types of managed accounts. We will begin with the traditional approach. The trader transfers his or her investment to the account manager, often via a bank transfer and he or she manages the account for you. The immediate risk is the account manager either disappearing with your investment or that heavy losses will be made despite the promises for a conservative market exposure.
If you opt for an account manager he or she must have a reputation in the financial field. Searching their names on the internet should provide you with enough information as reputable figures will mentioned in the local financial news in your country or at larger global scale such as the Wall Street Journal (WSJ). If you are unable to discover anything proceed with extreme caution as this is an early sign of a fraudulent activity.
In a scenario where you are able the account manager is reputable and trust him or her with your capital, we suggest providing the account manager with half of your investment and see how matters are being handled. If after 6 months you are satisfied with the performance, the reports you received and withdrawals, ask for the entire investment to be withdrawn to you.
Upon receiving the funds you may then increase your investment gradually, If you are unable to receive your investment back form the account manager, you have fallen into a fraudulent activity and the matter should be forwarded to correct department in your country that deals with such matters. Taking a look on the brighter side if possible, you only sent half the investment to the account manager.
The Other Type
The second type of managed account is where the account manager has access to your trading account but the funds are not wired to him or her. This can be done by providing the account manager with your account number and broker or via an algorithm that provides the account manager with full control over your account.
The first alarm bell is the commission structure. A respected account manager will not charge a monthly fee regardless of his or her success during the month but adopt a ‘Watermark’ model.
Watermark means the account manager will not earn any commissions if the account is not profitable by the end of the month but not just profitable. The account balance must be above the invested capital and the commission will come off the profits he or she has earned. To clarify, let’s your investment is $10,000.
If by the end of the month your account balance is now $11,000 that means your Return on Investment (ROI) is 10%. Out of the earned $1,000 (10% ROI), the account manager may charge anywhere between 20% and as much as 50%. If by the end of the account manager has posted losses and your account balance is below $10,000, the account manager will not be entitled to any commissions.
Proceeding with the scenario that your account balance is now $11,000, if during the next month the account manager reduced your balance to $10,200 and in the following month he increased your balance from $10,200 to $10,900, the account manager will not be compensated until the balance is back over $11,000.
Adopting a Watermark system shows the account manager is confident in his trading system and that it is likely to be legitimate. By choosing not to adopt the Watermark model, the account manager must provide an adequate reason why as it shows he or she are not fully trusting the trading strategy and are merely seeking to be paid under any circumstances.
Although some would say this is insufficient, the account manager must at least one year of a documented track record. The account manager must provide you with the record as well as the following information:
The maximum leverage that were used per trade
The maximum leverage that were used for all open trades
The maximum drawdown throughout the track record
The largest loss that was incurred in a single trade
The largest profit that was made in a single trade
The financial instruments that were traded
The strategy type, swing, scalping etc.
The maximum number of trades per day
The maximum number of trades per month
The ROI for each month
This information will allow you to assess whether the account manager’s trading strategy meets your expectations and is inline with how the risk is managed with your investment. Failure to deliver the above should be seen as a distinct warning sign.
To conclude, a thorough research must be made when it comes to selecting an account manager. There may be decent account managers but such research is required to prevent any fraudulent activity. Of course, some form of a written agreement or contract is required, signed by both parties.
When it comes to binary options account managers, this field unfortunately is currently filled with fraudulent activity and we strongly suggest refraining from it at the time of this writing.
Trading Signals, Forex and Binary Options
If a trading signal provider openly states you will make any amount of money in a day, week or month this is a loud and clear warning.
A trading signals provider cannot guarantee or commit to how much profit can be made as it does not control the trade sizes or which trading signals you decide to dismiss, use a bigger trade size or a smaller trade size. If you pay a close attention to the trading signals agreement you will notice there is no commitment to how much money will be earned at any period of time following the binary options trading signals that are issued by the provider.
Falsifying the track record is very common in both binary options and in the Forex market. We will soon discuss the steps we have taken to legitimize our track record but please note we have encountered numerous trading signals providers that are dishonest and that even those that provide their real trades performance have removed losing trades.
The most fraudulent activity appears to be taking place in binary options trading signals providers. We would like to show you an example of how a trades performance is falsified:
Open Trades Part I
Please click on the screenshot to enlarge:
From the above you can see the account is over $100,000 profit. Give us $200 and will make you a lot of money, right? Well, no. What we are not showing you are the trade sizes and date the positions were executed. We have a good reason for choosing not to reveal this information, see why:
Open Trades II
Please click on the screenshot to enlarge:
You can now see those trades were opened over a year ago. The trade sizes we used were blown out of proportions. if the market did move against us we would have lost all the money. Such trade sizes require more than the $200 we have asked you for earlier and the risk of losing the entire investment is significant. Many traders do not understand this and only focus on how much money was made and not paying any attention to the trade size and the leverage.
One more important detail, this is a demo account of course as we would never have such exposure or use that much leverage with our investment. Falsifying performance is easy and there are other sophisticated ways then the one we have brought as an example. We have taken significant steps to show we provide real performance as we will soon discuss.
To ensure the trading signal provider is legitimate and is indeed successful it must provide the charts when the trade was initiated as we do in for our spot Forex trade alerts. Having the chart that was used for the trade alert on the website and sent to traders that follow the trade alerts means the trading signal provider does not falsify its performance.
We adopted the same approach for our binary options trade alerts, the chart, date and time is fully documented to reassure traders we are providing real results. If these steps are not taken traders must immediately question the reliability of the trading signals. A track record must be provided of course but again this can easily manipulated, which is why we are using the charts to show nothing is being manipulated.
Certain trading signals providers charge a monthly or a biweekly fee but if you open an account through a certain broker you will have the signals for free for a limited period of time. When the trader does open an account through the broker the signal provider is working with, the signal provider will be paid over $100 (usually it is at least $200) by the broker.
The aim of such providers is to secure the payment from the broker while paying less attention to continue their relationship with the trader. We are not collaborating with any brokers at the time of this writing, which is why it is in our best interest that you will be satisfied with our performance.
To summarize, there are many fraudulent activities in today’s markets. DDMarkets has taken extreme measures to legitimize its trade alerts by documenting all the required information to assess the quality of our market analysis.
Please Tell Me Why
Social trading based on our conclusion is an alternative to trading on your own if you are personally familiar with the signal provider such as family or close friends. If not, as long as a watermark model is not adopted we find the risks to be greater than the benefits.
Automated EA’s are undesired based on our arguments. You must test each EA with a magnifying glass and remain on the alert virtually 24 hours a day in case the EA will be unable to adjust to the market conditions.
There are EA’s that have proven themselves over time but such EA’s foe the retail market are not offered for sale nor they are published any where. These EA’s were developed by traders that probably took them a number of years to develop and test.
Managed accounts is a solution. It requires the account manager to submit all the information we have suggested and have earned his or her reputation as a leader in the field over the years. It does require time to investigate and study the data but as long as the precautionary steps we have suggested are taken the risk is limited.
Trading signals for binary options and Forex is safe to use based on our arguments in this article but the trading signals provider must take significant steps to prove it is providing real trades and real performance. Trading signals are designed for traders that are familiar with the market but are unsettled with their trading strategy or have simply been unsuccessful due to multiple reasons.
Your trade sizes in either binary options or Forex trading will determine if it can be benefited from. If you are trading small trades you must see whether the potential profit covers the costs of receiving the trading signals. This can be determined from the trade performance.