Emotional Algorithms in Trading (Part 1)
Trading in financial markets is one of the most stressful, risky, but attractive jobs. Every day, many people or companies with small and large capitals, to earn profit and income, deal in various financial markets, including the stock exchange, forex, and cryptocurrencies.
The key point to success in these markets is the ability to predict the general and specific trends of the market in a certain period. All traders and market analysts try to correctly predict the trend of fluctuations in the price of an asset or an entire financial market with various analytical methods and buy or sell their assets based on that.
As a programmer and interested in the field of cryptocurrencies, I have been spending a lot of time studying the market and analysis methods and using trading algorithms to optimal deals in this market, and the following article is a part of my experiences in this subject. I hope these experiences are useful for you.
Market analysis methods
In general, there are 3 methods for market analysis, which are:
In this type of analysis, the attention of the analyst is on news and events that affect the entire market or a specific stock or cryptocurrency. Factors such as the beginning of a war or its end, the decisions of the governments to ban activities, regulation or raise interest rates and the like that can have a positive or negative effect on the market, or the announcement of a successful or unsuccessful update on a specific platform or network, fundraising by a company or news related to the failure of a platform or organization, strengthening or weakening the development team of a project, and the like, are factors that affect the price of a specific stock or cryptocurrency or a group of them.
This type of analysis is based on the repetition of a series of patterns and calculation parameters whose observation in the market usually leads to the same result and based on these patterns and parameters, the trend movement of the market or specific cases can be determined. This method is based on mathematical topics and statistical and logical analysis.
3.?Price action
As the name of this method suggests, its focus is on price changes. In this method, the main hypothesis is that the result of all fundamental and technical analysis sits in the price change, and if we can explain the price changes, that means we have been able to recognize the trend of the market. Although this definition is very general and in practice, this method has many similarities to technical analysis, but it has many fans and is used as an analysis method. In this method, the price changes of a cryptocurrency or a number of them are examined in different time frames and the analyst seeks to find specific and repeatable patterns whose observation can lead to the correct prediction of the market trend.
Which analysis method is better?
The answer to this question is not clear. Some people believe that price action can be a better method, because there is the output of technical and fundamental analysis in it, and some people believe that price action alone is not enough and the analysis based on it should be confirmed by at least one or two technical analysis methods. But in general, none of the analytical methods are perfect, and if a person aims to invest or deal on market by himself, who has to use all of the methods to get the best result and lowest risk? And it should be noted that no analysis can claim to be 100% correct and never make mistakes.
The main disadvantages of analytical methods for the general public
Surely, when we use analytical methods for trading and investing, we expect that our predictions will always be correct and that the result of our deals will bring us a lot of profit. But the facts say otherwise, because:
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1. Market analysis is specialized work. It is not possible to be a successful analyst just by knowing or passing a course and learning terms and understanding fundamental patterns and indicators. Success in analysis requires a lot of experience and sufficient knowledge in this field. In this case, experience is even more important and effective.
2. Market analysis is a non-stop and permanent process. An analyst can have a correct analysis when the analysis is his main job and he is always in the course of market developments and changes. Otherwise, the probability of prediction and analysis failure will increase greatly.
3. The factors that influence the formation of market trends cannot always be calculated or predicted. Sometimes some actions in the market, which are called Market Making and are carried out by people who have more information and capital, to gain more profit, make all the analysis difficult and fail. Unfortunately, these factors always exist and are part of the financial market.
Emotions, enemy or friend
Probably, if you have trading experience in financial markets, especially cryptocurrencies, or if you have taken analytical training courses, you have noticed that emotions are very controlling in decision making. In all the materials, recommendations, and training that I have read or seen so far regarding the tips and principles of trading, it has been recommended that the trader should master his feelings control and not act based on emotions. Even in algorithmic trades that are traded or analyzed by programmed robots, this feature that the robot is not subject to emotion is considered an advantage. So, it can be understood that emotions are our enemy in trading. You may agree with this theory, but I doubt it. Even if that's completely true, I prefer to turn an enemy into a friend, especially if that enemy is my feelings.
Let's dig a little deeper into market sentiment. In the price action analysis method that I explained above, it was pointed out that this analysis method says that all events in the market show themselves in the price. Price changes are the result of fundamental and technical events. But in deeper layers, it can be said that these changes are feelings that control the market trend. And emotions are also directed by external factors. Negative news and negative analyzes cause a feeling of fear, and the feeling of fear causes the investors and traders to sell and leave the market, with the start of selling and falling of the market, the fear intensifies and the fall continues until when some people overcome their fear or feel that it is the right time to buy and enter the market, at this point support is provided and the price drop stops, but fear is still the dominant feeling. With the release of positive news or analysis, emotions go towards peace and the continuation of positive news can cause a feeling of greed and entry into the market, the result of which is an increase in price and intensification of growth. It seems that this is a repetitive and predictable cycle.
But the important and questionable point is whether it is possible to predict emotions.
There are 2 immutable principles about emotions:
1. The result of emotion is the same in 99% of all people. That is, the result of fear in the majority of people is the reaction of escaping from the situation of fear and going to the situation of safe. In this case, the feeling of fear is answered by the natural reaction of selling and exiting the market and maintaining the value of the asset, which is considered a safe point. Also, the feeling of greed is answered by the reaction of buying and entering the market to gain more profit and stay in the market.
2. Emotions are very contagious. If a person or a group is afraid, they can transfer this feeling very quickly to the people around them or their audience and intensify its effect, and the same is the case with greed.
With this explanation, it can be said that although future emotions cannot be predicted, the results of current emotions can be predicted. Based on my own experience, I say that trusting your feelings is more profitable in the long term. To discover market sentiments, I trust my feeling, whenever I feel fear, I exit the market and whenever I feel greedy, I re-enter the market. Loyalty to this strategy in high-risk financial markets such as cryptocurrencies reduces risk in the long term.
Emotional trading algorithms
Automated trading algorithms?usually aim to avoid emotions and operate based on technical analysis or price action methods. But many traders believe that these algorithms and the robots they use usually do not make the expected results, and of course they are right in almost situation. But imagine if these robots and their algorithms act based on market sentiments and can quickly recognize the prevailing and current emotions and act in harmony with it, their efficiency will probably be favorable.
This is something I am currently researching and developing on it and will share the results with you soon.