In technical terms, neural networks area method of data analysis which consists of a large number of processing units that are linked together by weighted probabilities. The idea is that they can mimic the human brain in the way it works and learns from past experiences. Its a branch of artificial intelligence where the creation of neural network model leads to a computer program which is able to 'think' and 'learn' and this concept is the new buzzword in Forex Trading.
So how do Neural Networks Work?
The field of neural networks was pioneered by Bernard Widrow of Stanford University back in the 1950s. Today they are used in various industries such as image and voice recognition systems, industrial robotics and aerospace applications.
A neural network usually involves a large number of processors which operate together but each has its own individual programmed knowledge and access to data in its own local memory. A neural network is "trained" by being given large amounts of data and specific rules about data relationships (A breakout above a daily chart high is likely to continue higher). A program can then tell the network how to behave in response to an external stimulus ( buy a breakout above a daily high)
Neural networks, in FX trading can be used to extract patterns and detect trends from its rules base. A trained neural network is often referred to in FX trading as " A Forex Expert Advisor" ( EA). The network can provide projections and answer "what if" questions. In true terms, a neural network learns by example and are not programmed to perform a specific task.
The Problem with Neural Networks in FX Trading
In FX trading lots of vendors claim they have built neutral networks and artificial intelligence programs which can not only be programmed with rules, they have the ability to think, learn and trade the market better than a human. By using pattern recognition, it then predicts and trade currencies for profits but this is absolute rubbish.
Let's look at how advanced artificial intelligence has become and you will see why, neural networks can never trade Forex markets better than a human and any simple trading system for that matter, based on trend following.
The Most Advanced Artificial Intelligence Neural Network and a Stunning Breakthrough
In 2010, a team from Berkeley's Electrical Engineering and Computer Sciences department, got a robot to fold towels of different sizes, solving a key problem in robotic engineering -- how to deal with flexible, or "deformable," objects. So we are a level where a computer can manipulate "deformable objects" – I.E. something which is flexible and not rigid, where the shape isn't predictable.
Now this is major breakthrough in artificial intelligence and neural networking but if you think about it, this is still a defined object. Currency markets are NOT a defined object. In terms of the towel folding its scientific and the rules are specific to help it fold the towel and the outcome, will be the SAME every time.
In terms of FX trading, this is not so. The idea of neural networks and artificial intelligence in Forex is to find patterns that are predictable and trade them, to give the trader an edge but Forex markets are not scientific!
Traders will always look for recurring patterns which they think haven't be seen by humans and a computer can find them and predict with greater accuracy. How can this be true though, when markets are illogical and are made by humans which don't confirm to any objective rules?
You have guessed it, these neural network FX trading systems, are simply sold by vendors to appeal to naïve traders who think they can predict Forex price action but they soon learn, there is no way to beat the market.
I quite like the idea of a robot folding towels and do set chores and also saw, an artificial intelligence robot for sale the other day on the web. With its advanced application of neural networks and fuzzy logic, it claims 95% accuracy in trading ( well if it really can predict the future with science it should be 100%) the cost for this breakthrough program $97.00!
Anyone who buys a system in FX trading based on neural networks or artificial intelligence is either very naïve or has no concept, of how and why Forex prices really move. In conclusion, avoid neural network FX trading strategies or you will end up losing your money.