What are the characteristics with which we can describe and then distinguish the styles of different Signal Providers?
It should be stated at the outset that each Signal Provider, or each Retail Trader in general, has his own style.
It’s very difficult to find two traders who do the exact same operations, even if they did the same trading course, with the same instructor, and have the identical knowledge. In the trading style of each person there are also their own personality, their own experiences and their own expectations, all of which will never be the same between one person and another.
If the operations are totally identical, it simply means that both are using an Automated Trading system, ie an Expert Advisor.
That being said, there are certain parameters that a reasonable Follower investor should consider every time he intend to analyze the performance of a Signal Provider, before deciding to follow his signals.
Let’s see the most important in detail.
How long the Signal Provider has been working?
That’s the first point, the most important place to start. The first thing to do when you look at the Signal Provider’s statistics is noticing his age. Not the trader’s chronological age, but how long the trader has been connected to the Social Trading company, and how long his data have been recorded and made available for consultation.
It’s clear that the statistics that are based on data recorded for only one month will be much less relevant and useful, for the purposes of the analysis, of statistics of two or three years. As a general rule, it’s essential not to go below a year, as a minimum. If a Signal Provider shows very good performance, maybe even safe, but has not yet completed a year of “age”, then it’s better to wait to connect him, and observe him again in the future.
The reason is simple. Markets are always changing, and it’s important to see how a Signal Provider behaves in different situations. Usually in a year’s time a Signal Provider will have faced various market’s scenarios, and you’ll be able to look at how he behaved.
Otherwise, if you trust a trader with only a few months of great records, you risk to connect to a strategy that worked well only for that particular moment in favor of the market. But, finished that period, you don’t know what to expect, and there may be unpleasant surprises.
Number of instruments used
There are Signal Providers that trade on several currency pairs or stocks. There are others who specialize exclusively on just one or two.
This is another important point to focus on, not because it’s better or worse to do one or the other thing, this is subjective and each style has its strengths and weaknesses. More than anything else, it’s important to contextualize another details we will see shortly, that is the maximum number of transactions open simultaneously.
In the case of Forex, but the same goes for CFDs, traders who use different currency pairs usually prefer to decrease the risk incidence by using their technique on multiple currency pairs.
Some simply use the same strategy on several pairs, considering that if with a certain pair at some point it will perform badly, there will be others in which instead it will do fine. On average, this will always lead to a positive result, and in the meantime he will avoid to go through completely negative periods, as it would be in the case of using the strategy on a single pair.
Other Signal Providers, instead, use complex diversification strategies, that take into consideration different parameters and technical data, including the most important positive and negative correlation between instruments. It is called positive correlation when two instruments, in our case two currency pairs, move more or less in unison, in the same direction and at the same time. On the contrary, it is called negative correlation when they move on the contrary to one another.
The other category, instead, refers to those Signal Providers who focus their strategy on one or two currency pairs or company’s stocks. These traders tend to specialize and deeply understand the behavior of the instrument on which they operate, and are able to recognize the various phases that particular instrument is going through, and can therefore adapt their strategy if necessary.
In case they use Expert Advisors, Signal Providers optimize as much as they can the automatic strategy, to reflect as much as possible the peculiar behavior of that instrument, in order to obtain the maximum return.
Number of trades open simultaneously
Most (not all) of the Signal Provider, either if they diversify on different pairs, or if they focus on a single one, at a certain point of their trading life they will end up having more than one operation open on their account at the same time. This can happen for several reasons we will see shortly.
The important thing is to begin to understand that this is one of the most important parameters to consider.
In general, increasing the number of simultaneous trade can quickly increase the level of risk, although this may also not always be true.
Let’s consider a Signal Provider that, historically, had moments when he found himself with a maximum of 20 simultaneous operations. I can already anticipate you that 20 is a value that, taken individually and out of context, could be risky, but let’s move forward in the examination. Indeed, the Signal Provider has diversified its strategy on 10 different currency pairs, and each pair has maximum 2 open simultaneously operations. Now, obviously the value 20 takes a whole different meaning.
As we will see later, however, a large number of Trade opened at the same time it’s often the first detector of a risky strategy. Soon we will see why.
Average number of operations performed
Does the Signal Provider open a few or many transactions per day? Or per week? Or per month? Numerically, how many is “few”, and how many is “many”?
To this type of questions we can answer as we did by referring to the number of simultaneously open trades, saying that everything can be relative. A trader who opens an average of 10 trades per day, and uses 10 different currency pairs, will be different from a trader who will instead open 10 trades per day, but on a single pair.
Understanding why a Signal Provider opens more or less transactions is something that would require the full knowledge of the strategy used by him, which, except for a few cases, is not possible to know.
But what we can do is identify how many transactions the trader makes on average per day, per week and per month. One of the first methods for controlling a Signal Provider’s actions is derived from these parameters. If I notice a significant increase in the number of the daily, weekly or monthly trades, it means that something has changed in the trader’s strategy, or simply that he’s beginning to no longer respect it as before.
In any case, this way you’ll find out right away if there are any changes, and you can make your considerations.
The duration of a trade greatly affects the connotation of a Signal Provider style. As we have seen, even during the forex course, traders can be divided into three main categories.
There are the Trend Follower traders, that implement long-term strategies. Here, each operation is open to ride the long trend movements, and they can remain open for several days or even a few weeks or months.
Then, there are the Swing Traders, those who open positions to earn from the market swing, which are usually closed in a few days, usually within a week.
Finally, there are the Day Traders, whose operations are always closed by the end of the trading day, and among these, Scalpers, the fastest ever, that open and close many transactions that are maintained for a few minutes, if not seconds.
The number of operations that a trader will be able to close with profit will form the Signal Provider’s winning percentage.
This is a number that can be very relative, and that needs to be contextualized with another parameter to make a concrete contribution to the analysis, as we will see shortly.
The key thing to do with this percentage is to be wary of extremes. Obviously, it’s easy to be wary of a Signal Provider who terminate in profit less than the 30% of the trades, because it means that his strategy is very week. But we must be wary also and especially when percentages are too high, generally ranging from 70% upwards.
Some might argue that the higher the percentage the more the trader’s strategy will be safe, because it never loses. Well, the problem is precisely that. A no-losing trader has never existed, and will never exist. Losing every so often, when trading in the markets, it’s a normal thing.
If you find a trader with a winning percentage of over 70%, it doesn’t mean he’s very good, but simply that he tends to avoid of closing the losing operations, leaving them open for a long time in order to not take the final loss, in the hope that sooner or later the price will return on the right side.
This is a very risky strategy, because the market can go against you much longer than what your capital can support, regardless of how much liquid you are.
To cut losses is crucial, those who do not run a very big risk, and if you decide to follow this kind of strategies, you will inevitably run it too.
Remember, the market takes no prisoners, and those who are not willing to suffer a small loss are destined, sooner or later, to suffer the biggest loss of their life.
Risk / Reward
The risk/reward is calculated by relating what an operation aims to gain with what is willing to risk.
If a trade has 100 pips target and the stop loss is set at -50 pips, the risk/return ratio will be 2:1, or directly 2 making the division 100/50 = 2.
Another example, if the expected profit is 75 pips and the stop loss is set to -60, the risk/reward will be 1.25 (75/60 = 1.25).
When the risk/reward ratio is greater than 1 it means that the expected profits are greater than the losses, as a number of gained or lost pips. Conversely, if the risk/reward is less than 0 it means that losses outweigh gains, as a number of pips.
This value is very useful when correlated with the winning percentage. In fact, in addition to knowing if the operations of the traders get a number of pips higher than what they lose, it’s essential to know how many times, on average, that trader gains or loses, because the scenario could change a lot.
Let’s consider a risk/reward of 2. It means that a successful operation can earn twice of what it can lose. This sounds great, but then we discover that the winning percentage is only 30%. So, despite the fact that the Signal Provider, when he wins, take much more pips compared to when he loses, the times when it loses are much more than the times in which he wins. Such a strategy has a major deficiency.
Another example. A risk/reward ratio of 0.70, so with losses greater than gains, but with a very high winning percentage of 68%. A trader of this type has stop wider than profit, but the times the stop is taken are much lower than when the trade goes into profit. Most likely, such a trader will be profitable in the long run.
Using risk/reward ratio is very useful when we find Signal Providers that have a very precise operation style, with average levels of profit and stop always equal. In such cases, doing the calculations is very easy and convenient.
Now that we have listed the main parameters for which a Signal Provider can be analyzed, in the next lesson we will look at the most popular categories of traders.