Following Forex Trading Signals Is Dangerous To Your Wealth

By | November 15, 2015

I’m not going to refer in this article to obvious scams, like those robots attached to fake track-records at dubious brokers (Synergy FX for instance). What I’d like to point out is that even the signal sellers who, for all we know, act in good faith, are in 99% (there’s that saying, ‘never say never’) of cases just accidents waiting to happen.

The first thing that should be kept in mind is one major flaw of this business model –  the interests of the signals seller and those of the person who copies them are not aligned. When the signal seller makes money based on the volumes traded by his followers and not based on a percentage of the actual profits he made for them, you know there’s going to be trouble ahead.

The other major problem, not as obvious as the first one, is that the average investor doesn’t have the time or the know-how required to properly analyze the track-records and the statistics on sites like Myfxbook. Most people will look just at gain/draw-down and the higher the ratio, the more attractive the system will appear.

Well, there are many funny sayings about statistics, such as: ‘there are lies, damned lies and statistics’ or ‘statistics are like bikinis; what they reveal is suggestive, but what they conceal is vital’.

That’s the very case with the gain/draw-down statistic. It reveals that up to the present time the strategy has made money. But because it’s backward looking and limited, it conceals the vital part, how the strategy is likely to do in the future. To give you an example: let’s assume a crazy person plays Russian roulette (where you load one bullet into one chamber of a revolver, spin the cylinder and then shoot at your head) and survives the first 8 rounds. Would you call this low risk ? Just seeing a gain/draw-down chart for this activity, it would appear so. But if you actually look beyond that and see what the guy is doing, you’ll instantly realize both how misleading the statistic is and that you can’t put your money on this guy.

In order to find out who is playing financial Russian roulette (unaware perhaps), you need to know the Value at Risk (VaR), which is a risk measure that takes into account the frequency, leverage and duration of individual trades and also the market conditions (like volatility and correlation between pairs). For the time being, in the retail space, only Darwinex calculates VaR  and they also standardize all investable strategies (called DARWINs) for 20% VaR. For those interested in this important topic, here is a webinar addressing Value at Risk in more detail.

And now I’ll give you an example of  the hidden danger I mentioned above. This signal provider is ranked high (no.7) by Myfxbook in their auto trade systems feature. I chose him on the following additional criteria:

  • manual trader (all other things being equal, I believe a one year track record of a human is more honest than that of an EA. At least it shows there’s some work put in there, to watch the market, enter and close the trades. With an EA, it feels like analyzing the winning lottery ticket – the developer might have bought/developed 20 EAs a year ago and just got lucky with one.
  •  the history is shown
  • there’s at least 1 year of trading
  • no gaming of the gain/absolute gain system
  • I got intrigued by a name such as SPM Capital Management :)

With a 96% return for the past 12 months and a draw-down of only 14.5%, what’s not to like ? I looked up the name and found him on this forum. Seeing how this guy talks was the first sign that he might just be a lucky survivor of a year’s worth of playing Russian roulette:

In the last 12 months I have almost doubled the account, and in the next 12 months I intend to triple it. – post no.7

Digging more deeply into the track-record what do we notice ? Open trades are a mess – 17 trades with no stop loss and several being just averaging down. Going through the history, the same tendency to avoid closing losing trades and instead wait for the price to come back is evident. So far he has been able do dodge the bullet, but this by no means implies safety going forward.

To conclude: I strongly believe that following/copying forex signals is a money losing proposition in the medium and long term. In the short term, it’s a coin toss at best.

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