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Neural Networks for Forex Trading

The automatic trading and trading algorithms are common for contemporary forex traders. Neural networks (NN) are gaining popularity within the forex trading community due to their simplicity and efficiency. That is why it is important to understand the principles of NN and recognize their limitations. It is equally important to dispel the myths and misconceptions about the NN as the supernatural force capable of predicting the future.

One of the common misunderstanding is that the NN is some kind of artificial intelligence capable of replacing the human thinking and intuition. This naive notion of a certainly valuable trading algorithm is dangerous.  To understand what NN can and cannot do we should look into what they are.

First of all, NN are algorithms loosely inspired by the idea of connected neurons in the human brain. The neurons are represented  by nodes which accept an input signal from other neurons and produce an output. The system of interconnected nodes can be trained to produce a certain input given a series of outputs.  The training is simply an adjustment of certain numerical values (weights) associated with every neuron.  

Therefore, NN  are designed to  detect the arrays of inter-dependencies in the data that are hidden from the human eye due to the complexity. This has been proven by the variety of practical applications. Relevant mathematical theories have been published in numerous research papers in academic journals.  In other words, the applicability of the NN to certain practical applications is unquestionable. However, on no account should you consider NN to be something that will think or decide for you.

The next dangerous misconception originates directly from the first one. This is about the magic trading software that basically works as a money printing machine. All you need to do is find it and tune it properly to serve your needs.  As a matter of fact, those who try to exploit these delusions are poor professionals and, thus, poor software developers.  A NN program can do only what NN themselves can do which is actually a lot if you know how to apply them. However, no NN can tell you the exact time and the type of action you should take at this particular time. If such software existed, it would be able to basically predict the future. Then  we would be able to answer questions much more important than a price of a currency one second or one minute from now.      

The next misconception is that NN  are able to predict the future prices in other words they can entirely replace your enter and exit strategy. However, no neural network, no matter how well-built is able to accurately predict the future price. However, in some cases NN can evaluate the likelihood of other important things, which could  help you in your trading decisions.

Many forex traders who want to employ artificial intelligence algorithms such as NN believe a special structure and training of the NN can significantly improve the results. The practice shows that the quality of different neural networks, no matter how much the programmers tweak the code differs within the range of 10%. Moreover, sometimes too much training data actually decreases the accuracy.  This is what the specialists in AI call the “over trained model”. Of course, while selecting a trading software program one should look at the AI  background of its developers. However, looking for the magic NN is much like looking for one magic Holy-Grail-forex-indicator.

Nevertheless, much depends on how well the trader has prepared the data. The data must be  representative and include all the important impact factors. The data must be split into the training and testing sets approximately as 70:30. The training data set makes it possible to establish the correct connections between the neurons. Next, the accuracy / predicting power of the NN must be evaluated independently on the remaining 30% of the data.

Of course, just like any other method, neural networks have their advantages and limitations, but their unique ability to track even the most subtle inter-dependencies in the available data no other method can establish.

Therefore you can effectively use NN to:

  • estimate the likelihood of a trend;
  • classify market phases;
  • generate time estimates of highs and lows for different timeframes and combine the results;
  • predict the probability of a new, strong upswing after an uptrend, followed by a classic correction;
  • track inter-market dependencies.

When NN are combined with other techniques of forex technical analysis and when the training data sets are well prepared (the central procedure to success), NN can without a doubt provide with the punch you need to success on the market. After all, their efficiency has been proven by time and experience by many applications inside and outside the world of finance

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