Scalping & EAs – Healthy or Toxic Order Flow?

Foreign exchange trading is widely used by traders as an investment product because currencies allow traders with different strategies long

Foreign exchange trading is widely used by traders as an investment product because currencies allow traders with different strategies long and short term opportunities. Currencies are the most liquid financial instruments and due to the vast ranges in daily movements traders can source profitable trading opportunities.

One such common trading strategy isscalping. For many years scalping was a taboo as forex market makers frowned upon traders who even thought about executing this ‘in and out’ approach. However the tables have turned and as the market has matured; some participants are ready to fill this gap, scalping is now the ‘in’ thing.

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“We accept scalping EAs” is a marketing phrase used by many brokers who are looking to welcome the volume rich Expert Advisor users. The retail forex markets have undergone a major transition from unfriendly anti-scalping to very friendly service with a smile. Brokers have also been using special promotions like cash bonuses to give automated traders more incentive to become customers. This has been due to many reasons. However, the fundamental point is that EAs, and in particular scalping EAs, account for a significant amount of volume in the forex markets. As such, in times of stagnant trading activity, EA flow can simply become something brokers can’t refuse.

MetaTrader4_overview

Expert Advisors – What Are They?

The ‘auto trading’ phenomena is a new concept that hit the online trading markets over the last few years. It has become an industry norm and now extends its reach even amongst laymen in the forex trading environment. It has gained popularity as people feel it is an ideal substitute for those who lack time or knowledge to trade. EAs can be defined as a piece of software written specifically
for the MetaTrader Platform. An EA can (automatically) advise traders which trades to make or can be programmed to automatically execute the trades on a live account. Expert Advisors are very flexible pieces of software that can take any information into account that is available on the MetaTrader platform.

They are written in their own proprietary programming language called MetaQuotes Language Version 4 (MQL4). EA automated trading strategies come in many shapes and forms. Traders can code them by themselves using MQL4 or purchase them from independent software vendors. Prices run from just a few dollars to over $200 for well proven products.

Currently, they are readily available on sites such as eBay as well as on EA focused websites. In the early days of the EA bubble, traders were lured into the extreme money making robots by glamorous marketing campaigns using affiliate marketing and backed up with statements from MetaTrader users showing profits and returns of 100% in less than 100 days. As the myth suggests, 95% of traders lose money therefore any thought of profit in the forex market was a bonus.

Gaining Popularity

EAs have grown in popularity in line with the overall growth in forex trading as an investment product. Although the myth of 95% traders making losses is still floating around, in general traders are getting wiser and making better informed decisions, as reflected by the client profitability figures issued to the CFTC by US based brokerages and published every quarter by Forex Magnates.

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Traders are more literate about the dynamics of trading and understand for example what causes re-quotes and latency, best trading sessions to operate in, etc. Thus, traders can try and eliminate certain factors that were causing difficulty in their trading.

One major factor that was discovered that affected EA performance was the choice of a broker. Some brokers were ‘auto-trading’ friendly and had the knowledge and know-how to manage the complexities involved. Others would claim to be EA friendly when in fact their infrastructure lacked the finer points that can cause a trading strategy to make or lose money. Traders caught on to this and have been able to easily identify the unsupportive brokers by simply looking out for re-quotes, slippage and off quotes.

Most EAs are tested on various trading platforms with brokers offering different depths of liquidity, pricing, definitions of strategies like scalping and views on how they manage risk.

Jeff Wilkins, Managing Director at ThinkLiquidty says “EAs have different success rates at different brokers because execution varies across different brokers, this is something traders need to understand. It is important for a trader to differentiate between a natural drawdown of the EA strategy and negative effects due to poor execution. If an EA is struggling due to poor execution, it is time to change brokers”.

Similarly when asked why some EAs work better at some brokers than others, Ibrahim Abu Aita, Co-Director at CM Trading, who manages his firm’s trading and risk responded “Some brokers implement system settings that contradict with the EA core requirements. For instance: Some EAs require fixed spread rather than floating, limited slippage, large price deviation. On the other hand different brokers can choose different methods and policies to execute orders, methods that have a direct impact on EAs functionality. For example: harsh settings in MT4 Virtual Dealer.”

At one point brokers were defending themselves from the use of EAs. This changed when traders were complaining about brokers’ poor performance on all the trading forums in 2009. Brokers then began responding with messages that included ‘All EAs welcome’ and ‘Scalpers welcome’. Interbank FX had taken the EA theme to the next (and controversial) stage as their subsidiary IBFX Australia officially associated themselves with an EA. The group partnered with Buru Partners in the marketing of the Buru EA. The EA became very popular due to its results and as it was only available through IBFX – boosting the broker’s trading volumes. When IBFX first invited their clients to trade using Buru the EA had very interesting results:

* Average Weekly Return: +2.5%*

* Average Monthly Return: +10.7%*

* Full History of 267 days: +151.06%*

Eventually, as happens with almost all EAs, the Buru EA suffered losses and accounts were wiped out. The EA followed the fairly popular ‘Martingale’ style of doubling down as a trade
goes under water. As can be imagined, the strategy produces small consistent winners during less volatile times but can lead to huge losses in a quick moving trending market. As such,
although the Buru EA had produced quality returns, it failed to protect traders during a period of violent movement.

This is an excerpt from a full feature on EAs and Scalping in the Forex Magnates Industry Report for Q4 2012.

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