Sunday, April 26, 2015

Consistent and safe Forex algo trading | The OmiCronFX Mandelbrot routine avoids the dangers of “spoofing”.

As always, the Forex market will only allow one to take from it what is available - there will always be periods when the volatility that is required for profitable trades will not be present. The challenge then is to ensure that there are minimal if any losses in order to be able to make hay when volatility is present in the way that is beneficial for an algorithmic routine like Mandelbrot. We estimate that those periods conform to about nine months of the calendar year. For this reason we project our potential profitability for a full year by compounding a typical profitable month over nine months instead of twelve. This is a conservative approach. In the meantime we are continuously monitoring and analysing results, and the historical record of price changes, in order to ensure that the underlying assumptions of the software remain valid.

The OmiCronFX Mandelbrot routine avoids the dangers of “spoofing”.

Mandelbrot works exclusively on price action - by being able to react instantaneously to the price action patterns that it has discovered to exist in the large variety of scenarios that are found in the Forex marketplace. This means that it is concerned only with the concrete trading actions of other traders. It has no regard whatsoever for the order book of pending orders, upon which so many trading algorithms, even those operated by the largest and most sophisticated algo traders, are based. Recent publication of charges being brought by US regulatory authorities against Navinder Singh Sarao, a lone gun trader operating from London, England, highlight how vulnerable such strategies are. Put simply, Sarao is alleged to have manipulated the order book so that it showed massive amounts of pending trades that were nothing of the sort, but rather spurious entries that were designed to fool the algorithms of other traders that relied on high order flow to decide when to buy and sell. Falsifying the order book in this way is known in the industry as “spoofing”.

There is debate about whether or not the activities of Sarao contributed to the flash crash of May 2010, when the Dow Jones fell 600 points in a number of minutes. This debate is almost beside the point. What is very much to the point is that it was, and perhaps still is, possible for the order book to be manipulated in a manner that gives the individual concerned a grossly unfair advantage over some other market participants, i.e. those who study the order flow as part of their strategy. Trading is always a zero-sum game - for anyone to profit, other traders must lose.

If a single individual, operating alone outside of an institution or hedge fund, can manipulate the order book to the degree that is alleged in the charge sheet against him, then how much more scope for this kind of activity is there for much larger, equally unscrupulous but somewhat more subtle market participants?

No, Mandelbrot only takes notice of actual positions that have been entered into, not batches of pending orders that are subject to cancellation. Sarao requested his software supplier to code a  routine for him that would have a “cancel if close” function, in other words a facility to automatically cancel orders that had been placed outside the immediate range of prices in the event of price moving close to these pending so-called trades. It is obvious from this that these pending orders were never, ever, meant to be filled, and were only put in place to give the impression that demand was higher than it actually was and thereby create an illusion for other traders, who relied on the depth of the market for their, and their algorithm’s, trading decisions.

Our potential counterparties have to put their actual money where their mouths are, or we don’t want to know about it.

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