Considering the Pros and Cons of Automated Trading
Because financial trading involves constant monitoring, automation in the space is often marketed as a silver bullet. Automated software programs employ algorithms that can execute trades on your behalf, typically based on established parameters you’re able to define in advance. For example, an automated program can execute a “buy” order of a stock if it falls below a certain price, reducing the need for the trader to monitor live price movements.
The convenience of functions like this has led to expanding use of automated trading tools. In fact, platforms by EBS and JP Morgan now estimate that some 70-80% of trades originate from algorithms –– whereas in 2004, EBS stated that all trade orders were executed by humans.
As appealing as all of this sounds however, automated trading may not be for everyone. So before you look to incorporate these tools and strategies, consider the following pros and cons.
The Benefits of Automated Trading
Timeliness: Timing is a key factor in maximising gains and minimising losses in trading. Unfortunately, humans are unable to monitor markets at all times…. But trading bots don’t have that limitation! Automated trading tools, then, can help day and swing traders alike keep up with market fluctuations and make timely decisions. This is also a helpful perk when it comes to maintaining a more diversified portfolio. Monitoring assets across different markets requires more attention, but here too a bot can help to handle the minute-to-minute attention and decision-making.
Objectivity: Earlier this year, a survey by MagnifyMoney revealed that 66% of retail investors regret decisions they make based on their emotions. Additionally, 58% are in agreement that it’s best to keep emotions in check. This is another issue that can more or less be solved by automated trading tools. Trading bots don’t hesitate or act based on emotion when they execute market orders. They operate with pure, emotionless objectivity, which can helpfully balance out a lot o human investors’ natural tendencies to be somewhat more impulsive.
Backtesting: Backtesting is more of an analytical tool than an active trading mechanism. But it is nevertheless another perk of automation in trading. If you’re not familiar with backtesting, FXCM’s guide to trading platforms notes that it is one of the features you can find through online investing platforms like Trading Station. And what it does is essentially to assess the viability of a user’s trading strategy by evaluating historical data. In other words, it’s an automated method that helps you to optimise your strategy based on historical trends and present conditions.
The Drawbacks of Automated Trading
Anomalies: Many traders trust automated software not to make mistakes. Unfortunately, these programs are not yet entirely foolproof. Program errors can occur, lost or interrupted internet connections can interfere with trading, and various other discrepancies can occur. This doesn’t mean automated trading tools are always unstable, but neither are they 100% reliable.
Overconfidence: Unless your strategy revolves around more long-term investment, automated trading is not equivalent to hands-off trading. Nevertheless, some traders are inclined to get carried away with the implications of “automation,” ultimately becoming too confident in (and too reliant on) software. These tools are meant to be leaned on to some extent, but it’s important for traders to remember that they are not infallible, and they also don’t guarantee profits on their own.
Scams: The growth of automation has unfortunately also led to a rise in fraud. In 2018 for example, BitConnect investors were scammed out of almost $2 billion in crypto holdings by a bot. The trading bot they used guaranteed returns, but was instead instrumental in siphoning funds away from their accounts. Of course this doesn’t happen often, particularly on such a massive scale. But traders need to apply caution when evaluating automated trading services, particularly given that so many of them are new, and relatively unknown.
Bottom-line: Should You Automate Your Trading?
Automated trading can be helpful if you want to evaluate your strategy, maintain objectivity, and execute orders at lighting speeds. That said, it is also an imperfect practice, and should be approached with care and caution, if at all.
Ultimately it’s up to each individual trader to evaluate the pros and cons. And in most cases, even if you do decide to try automated trading, advice and guidance from human professionals is still the best way to improve your trading practices. If you feel you could use further guidance on this topic or on trading in general, get in touch with VSRK here.