The Advantages and Disadvantages of Automated Trading Systems

An automated trading system is what?

Automated trading systems, also known as algorithmic trading, automated trading, or system trading, let traders set up particular rules for trade entry and exits that, once programmed, can be carried out automatically by a computer. In reality, according to a number of platforms, automatic trading systems account for 70% to 80% or more of the shares traded on U.S. stock exchanges.

Traders and investors can create automated trading systems that enable computers to execute and monitor deals by incorporating precise entry, exit, and money management criteria. One of the main benefits of strategy automation is that if trades are made automatically when certain conditions are satisfied, it can reduce some of the emotions associated with trading.

The conditions for trade entrance and exit rules might be straightforward, like a moving average crossing, or they can be complex methods that require a thorough knowledge of the programming language used by the user’s trading platform. They may also be founded on a qualified programmer’s subject-matter knowledge.

Any special rules for automated trading systems must be defined in the platform’s proprietary language, and automated trading systems often call for software connected to a direct access broker. As an illustration, the TradeStation platform employs the EasyLanguage programming language. The NinjaTrader platform, on the other hand, makes use of NinjaScript. An example of an automated approach that initiated three trades during a trading session is shown in the image below.

Are trades automated on NinjaTrader? Setting Up Trading “Rules”

Some trading platforms feature “wizards” for developing strategies that let users choose from various widely used technical indicators to create a set of rules that can then be traded automatically. On a five-minute chart of a particular trading instrument, the user could decide, for instance, that a long position trade will be initiated once the 50-day moving average crosses over the 200-day moving average. The kind of order (market or limit, for example) and the time the trade will be executed (for example, at the close of the current bar or the start of the following bar) can also be entered by users, or they can utilize the platform’s default values.

However, many traders prefer to program their unique indicators and approaches. They frequently collaborate closely on system development with the coder. Although it usually takes more work than using the platform’s wizard, this method offers far more freedom, and the outcomes could be more satisfying. There is, sadly, no ideal investing plan that can ensure success, just like there isn’t in the trading industry.

Once the rules are in place, the computer can watch the markets and look for buy or sell opportunities following the trading strategy’s guidelines. Depending on the individual regulations, any orders for protective stop losses, trailing stops, and profit goals will be immediately generated as soon as a trade is entered. If the deal moves against the trader, this immediate order entry could represent the difference between a minor loss and a significant loss in volatile markets.

Gains from Automated Systems

The benefits of using a computer to execute transactions and monitor the markets for trading opportunities are numerous and include the following:

Reducing Emotions

Automated trading platforms keep emotions to a minimum while trading. Traders often easily stick to the plan by controlling their emotions. Trade orders are automatically executed after the trade rules are satisfied, so traders cannot pause or second-guess the trade. Automated trading can restrain traders inclined to overtrade, buying and selling at every opportunity, and assist those hesitant to “pull the trigger.”

Backtesting

Backtesting uses previous market data and trading rules to assess an idea’s viability. There should be no space for interpretation in any rules when creating an automated trading system. The computer is unable to hazard a guess; it requires explicit instructions. Before putting their money at risk in live trading, traders can use these specific rules and test them on historical data. With careful backtesting, traders can assess and fine-tune a trading concept and estimate the system’s expectation, or the typical amount per unit of risk that a trader can expect to gain (or lose).

Maintaining Discipline

Discipline is maintained even in turbulent markets since trade rules are defined, and execution is carried out automatically. Emotional considerations like the dread of suffering a loss or the desire to squeeze out just a little bit more profit from a deal cause discipline to be lost frequently. Automated trading makes it easier to keep discipline because the trading strategy will be adhered to precisely. Furthermore, “pilot error” is reduced. For instance, if a mistake is made, a 100-share buy order is placed as a 1,000-share sell order.

Making a trading plan and following it through is one of the significant hurdles. Trading plans may be profitable, but traders who break the rules change any expectations the system would have had. No trading strategy consistently outperforms the market. Losses are inevitable in any game, after all. Losses, however, can be psychologically traumatic, so a trader who has had two or three consecutive losing trades may decide to forego the next one. The trader has already ruined whatever hope the system had if this next trade had succeeded. Trading the plan consistently is made possible by automated trading platforms.

Accelerating Order Entry

Automated systems can generate orders as soon as trading criteria are satisfied since computers react to shifting market conditions instantly. A few seconds earlier entry or exit can have a significant impact on the result of a deal. All additional orders, including stop losses and profit targets for protection, are automatically produced as soon as a position is registered. Markets can move quickly, and it can be disheartening to see a trade hit its profit target or blast beyond a stop-loss level before the orders can be placed. This is avoided by using an automated trading system.

Trading Diversification

The user of automated trading systems can trade numerous accounts or different trading methods simultaneously. The creation of a hedge against losing positions has the potential to distribute risk over a number of instruments. A computer can efficiently complete tasks that would take milliseconds for a human to complete. The computer can generate orders, track trades, and search for trading opportunities across various markets.

Advantages Reduce emotional trading.

• enables backtesting
• maintains the trader’s focus
• Numerous accounts are allowed.

Cons

• Mechanical breakdowns may occur.
• requires functionality monitoring
• may not function well
• Issues with Automated Systems

Although automated trading systems have many benefits, there are some drawbacks and truths that investors should be aware of.

Mechanical Defects

The concept of automated trading appears straightforward: install the software, set up the rules, and watch it trade. Automated trading is a sophisticated trading strategy, but it could be better. A trade order might not be stored on a server but on a computer, depending on the trading platform. That implies that an order might only be sent to the market if an internet connection is recovered. The order entry platform component that converts the strategy’s “theoretical trades” into actual trades may differ from the strategy’s output in some other way. When employing automated trading systems, most traders should anticipate a learning curve. It is typically a good idea to start with lower trade amounts while the process is being polished.

Monitoring

Automated trading systems necessitate monitoring, even though it would be fantastic to turn on the computer and go about your day. This is due to the possibility of technological malfunctions such as connectivity problems, power outages, computer breakdowns, and system quirks. Anomalies could occur in an automated trading system, leading to erroneous orders, missed orders, or double orders. These incidents can be rapidly found and dealt with if the system is monitored.

Over-Optimization

Although not explicitly related to automated trading systems, backtesting strategies are used by traders to produce systems that appear fantastic on paper but perform poorly in a live market. Excessive curve-fitting that renders a trading plan unreliable in live trading is over-optimization. For instance, a strategy can be adjusted to perform well on the historical data used to evaluate it. Some traders mistakenly assume that a trading strategy must have nearly 100% profitable trades or never suffer a drawdown to be successful. As a result, specifications can be changed to produce a “near perfect” plan that fails when used on a live market.

Prevent Scams

Keep this in mind while you look for your ideal system: If something seems too good to be true, it generally is. Scams are prevalent. Some systems advertise enormous rewards for a minimal investment. How can you determine whether a system is real or fake? Here are some fundamental pointers:

Before you pay for anything or put any money down for a trading account, consider what you would have to pay for and always ask questions. You might lose money if you don’t.

By conducting thorough research, ensure you are well informed about the system. And before you commit, make sure to read the terms and conditions.

Are there any customer reviews available to read? Look for evaluations on third-party websites or even websites run by financial regulators.

Is there a trial term available for the software? Many fraudulent websites won’t provide you with a trial.

Automation based on servers

Traders can use a server-based trading platform to run their automated trading systems. These platforms usually provide the option to host pre-existing systems on the server-based platform or offer commercial strategies for sale so traders can create their systems. All orders are stored on the computer, and the automated trading system may scan for, execute, and monitor trades for a charge. This frequently leads to quicker, more accurate order entries.

Before Automating

Although the term “automation” may make the process appear more straightforward, there are a few considerations you should make before employing these technologies.

Consider whether you ought to employ an automated trading system. There are undoubted claims that you can make money, but it may take longer than you anticipate. Will trading manually be more advantageous for you? Since these trading techniques might be intricate, you risk losing money if you lack the necessary skills.

Make sure you grasp the ins and outs of the system and are aware of what you are getting into. Before using more complex trading methods, you should keep your objectives and strategies basic.

Also, keep in mind that no one strategy fits all situations. Determine your preferred approach, the context in which you want to use it, and the degree to which you want to tailor it to your circumstances. Naturally, all of that fits in with your ultimate objectives.

the conclusion

Automated trading systems, while enticing for a number of reasons, shouldn’t be used in place of cautiously conducted trading. Because technological malfunctions can occur, these systems do need to be monitored. Traders looking to reduce the risks of mechanical breakdowns may find a solution in server-based solutions. Remember that you need to have some trading expertise and understanding before using automated trading systems.

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Originally published at http://theopenwrite.wordpress.com on December 22, 2022.