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Introducing this Discussion on Algo Trading Expectations

Welcome back to the journey into algorithmic trading. Hot on the heels of an introductory article dealing with algorithmic trading concepts, and a tactical discussion on algorithmic trading software platforms, we arrive at a mental and philosophical reflection point.

This endeavor into algorithmic trading is about pushing the limits of learning, and applying a broad array of market theory concepts through a scientific lens, mathematics / statistics and computer science. However, a less popular area of algorithmic trading is psychology. Yes, psychology and the mental approach to trading are real areas, even if you’re performing 100% automated, systematic and unattended algo trading.

Well-tread ground among retail traders (non-institutional, non-hedge fund traders) is the pursuit of a “holy grail”. We are bombarded by messages everywhere, in many fields of life. Buy this, use that, and your problems will vanish. Okay, perhaps that’s an oversimplification, but I think you get the point. Onward.

The Definition (and myth) of an Algo Trading “holy grail”

In both active (discretionary) trading and algorithmic trading, the “holy grail” is usually defined as a trading strategy that is has high long term profitability with consistent returns. In short, it is the ultimate trading strategy.

Spoiler alert: the “holy grail” (based on this definition) doesn’t exist. Market regimes change, trends start, trends stop, ranges form, consolidate and eventually break out into new patterns. Even Ray Dalio’s “all weather ” hedge fund strategy was arbitraged away by a changing climate in interest rates, thanks to widespread central bank intervention on the global economy.

This begs the question, is there a “holy grail”, and if so, what is it?

A New Definition of the Algo Trading “holy grail”

Here’s a new definition: The trader can be the “holy grail”.

Long term profitability with consistent returns can be a state of existence for investors and traders. Examples abound if you study the market. However, this is not due to a single algorithm or trading strategy. The trader can be his or her own secret ingredient by doing 3 things:

1) Understanding their portfolio of algorithmic trading strategies

2) Understanding how to effectively design, backtest and optimize trading strategies

3) Understanding when to maintain their portfolio, when to execute, modify or shut down strategies according to changing market regimes

Why Does This Matter in Algorithmic Trading?

We are all subject to emotions, pressure, stressors and thoughts in all we do. Even if you have a black box algo strategy which only involves you checking the account balance periodically, I can guarantee you psychology comes into play. When (not if) your system(s) enter into drawdown (read: you lose money), your head will be full of surprise, sadness, anger and so on. Even in this scenario, especially in this scenario, your management of expectations and psychology will be the true long determinant of success.

Short version: if you expect one or two algo programs to be your ticket to decades of success, you are sorely mistaken.

Wrap Up

Thanks for sticking through this brief, idealistic conversation on trading psychology and successful trading. In my next article walking through algo trading, I’ll be looking at setting up the MetaTrader4 platform for some basic tasks.

Zach