Black Algo Technologies

Robustness – A Summary
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Official Definition of Robustness: In economics, robustness is the ability of a financial robot to remain
effective under different markets and different market conditions, or the ability of an economic model
to remain valid under different assumptions, parameters and initial conditions.

To translate that into simpler words:

A robot is robust if it can remain effective in changing market conditions

Types of Robustness

Robustness seems to be an overused word. Many people talk about robustness in a robot without
specific reference to any single type of robustness. There are many types of robustness, we will talk
about the first four.

1. Period Robustness
2. Seasonal Robustness
3. Timeframe Robustness
4. Instrument Robustness
5. Optimisation Robustness (To be covered in later chapters)
6. Parameter Robustness (To be covered in later chapters)
7. Portfolio Robustness (To be covered in later chapters)

Period Robustness

Definition: A robot is robust across periods if it can remain effective in different market periods

Market Periods can be characterised into 2 types: Generic and Strategic

Generic Market Periods

Figure 1: Six Generic Market Periods.

Figure 1 shows us 6 main generic market periods. In this case, we are analysing the performance of
our robots in these 6 periods.

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However, do note that some generic market period tables are 5 by 5 or larger.
5 by 5 - Y axis: Very Low Volatility, Low Volatility, Neutral, High Volatility, Very High Volatility
5 by 5 - X axis: Strong Uptrend, Uptrend, Ranging, Downtrend, Strong Downtrend

The 5 by 5 classification is just a variation of the original 2 by 3, but there is nothing wrong with the 5
by 5 or any larger classification.

If our Robot is effective across the 6 basic periods, this means that it is period robust.

Strategic Market Periods

Strategic Market Periods are defined by the trader. This depends on specific conditions that strongly
influence the asset you are trading. Of course, these specific conditions vary for different assets.

For instance, if we are trading EURUSD, the US Federal Reserve monetary policy will heavily influence
our trading. Hence, we analyse 2 strategic market periods: 1) Fed Easing 2) Fed Tightening. If you are
trading equities, an example would be 1) Just before earnings release 2) Just after earnings release

Application to Trading

Does this mean if my robot is not period robust, it is unprofitable?

That is incorrect. There are plenty robots that are designed to captured a specific market inefficiency.
Our aim here is to understand our robot’s characteristics so that we know how and when to deploy
them.

Seasonal Robustness

Definition: A robot is seasonally robust if it is able to stay effective despite seasonal effects

Seasonal Robustness can be considered a subset of Period Robustness.

A seasonal effect is any market anomaly or economic effect which appears to be related to the calendar.
We say that there exists seasonal effects in the market if there are repetitive behaviour in the markets
across time. There are five main types of seasonal effects.

Intra-Day Effect: Specific behaviour of markets on certain times of the day

Day Effect: Specific behaviour of markets on certain days of the week

Month Effect: Specific behaviour of markets on certain months of the year

Quarter Effect: Specific behaviour of markets on a quarterly basis

Multi-year Effect: The term sometimes includes multi-year effects, such as the 10-year (decadal)
cycle

In most cases, seasonal effects are not self-fulfilling prophecies, they are created by market
fundamentals.

For instance:

1) Forex markets are more active during certain times of the days because of global market overlaps.

2) January Effect exists because of tax reducing reasons.

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3) Markets tend to be quieter on the earlier half of the first Friday of every month due to Non-Farm
Payrolls.

Figure 2: Examining the January Effect. Credits: http://www.aboutsmallcap.com

Application to Trading

Why don’t we exploit this recurring inefficiency? It is definitely possible, but there are several reasons
this could be difficult:

1) Timing and extent of seasonal effects are unstable

Market participants are constantly trying to exploit seasonal effects. These actions influence the extent
and behaviour of the seasonal effects. Therefore, this creates a dynamic situation where the seasonal
effects are constantly changing.

2) Cost of trade too high

Reasons that the seasonal effect exist could be because the cost to exploit the effect is too high. The
high cost acts as a natural barrier to protect the seasonal effects.

3) Effect is priced in

We don’t believe the market is completely efficient, but we believe it is efficient to a certain extent. In
many cases, it is difficult to exploit a seasonal effect because the efficiency is priced in. For instance,
you may want to buy a straddle (an option structure that gains in value when volatility increases) during
Non-Farm Payroll because you expect higher volatility. However, the sellers of the straddle have
factored in the high volatility and thus price this into the straddle price (option premiums).

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Timeframe Robustness

Definition: A robot is timeframe robust if it is able to stay effective when trading in different
timeframes

Timeframe refers to our candlestick period (1min, 5min, 15min, 1hour, Daily etc). Our robot is
timeframe robust if its underlying trading strategy is effective in different timeframe.

We need to understand timeframe robustness in two types of market conditions

1) Our asset behaves like a fractal across timeframes

2) No fractal behaviour

Scenario 1: Our asset behaves like a fractal across timeframes

No we are not referring to the candlestick pattern when we talk about Fractals.

Official Definition of Fractals: A fractal is a natural phenomenon or a mathematical set that exhibits a
repeating pattern that displays at every scale. If the replication is exactly the same at every scale, it is
called a self-similar pattern.

To simplify it: A fractal is a pattern that repeats itself in different visual or time scale.

Our robot will always be timeframe robust when it is trading an asset that behaves as a fractal across
timeframe. If the market behaves in the same manner at every timeframe, there should not be any
difference in our robot’s behaviour.

Scenario 2: No fractal behaviour

A general rule of thumb is that noise (volatility) increases as we go to the lower timeframe. Our robot
will be timeframe robust here if its underlying logic is effective in spite of the different noise levels and
market behaviour at different timeframes.

Application to Trading

If our robot is timeframe robust, it works at every timeframe. However, this does not mean that we
are indifferent to the timeframe we trade.

We should trade on lower timeframe. This will maximise the number of trading opportunities per time.
Imagine if you average 1 trade per 5 bars. If you trade on Daily timeframe, you will fire 52 trades a
year (260 weekdays / 5). If you trade on 1 Hourly timeframe, you can fire 1248 (260 * 24 / 5) trades
a year. Hence, your profit will be 24 times higher (without considering the effects of compounding!)

Should we trade on the lowest possible timeframe?

Following the logic stated above, if we should trade on the lowest possible timeframe (1min for MT4),
we should be massively profitable right? Sadly and unsurprisingly, no.

It is unlikely for a robot to be perfectly timeframe robust. It is unlikely for an asset to behave in a
perfect fractal manner. As we go to lower timeframes, the noise increases. The asset behaves in a more
unpredictable manner due to real-time influences from current events, market microstructure and
speculation by market participants. This means that we should choose a timeframe that balances noise
reduction and profit maximisation.

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If our robot is not timeframe robust, we need to understand which timeframe is most suitable for our
robot in different market conditions.

Instrument Robustness

Definition: A robot is robust across instruments (assets) if it can remain effective in across different
instruments.

A robot is instrument robust if it performs as expected across different assets. This means the robot’s
underlying trading logic is capturing an inefficiency that exist in multiple assets.

Application to Trading

Instrument robustness is not a gauge of a robot’s performance. In fact, most robots are not instrument
robust. Robots are designed to capture specific market inefficiencies and these inefficiencies tend to be
instrument specific. Thus, it is not unusual that most robots are not instrument robust.

Instead of aiming for instrument robustness, we should understand how our robots work in different
assets. This will allow us to discover common inefficiencies in different assets and deploy our portfolio
of robots more effectively.

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