Automated Trading Systems: Plan the Trade or Trade the Plan?
Automated trading systems (ATS) are one way for traders to eliminate the grip of emotion during the decision-making process of when to open or close a potential trade. Traders, both experienced and inexperienced, have entered into or exited trades because they got scared, followed bad advice, or hesitated and failed to act at the right time.
A pre-programmed, thoroughly-tested, rules-based automated trading system removes the risk of irrationality. It can streamline and optimize your trading activity while helping you avoid the pressures of manual, over-the-phone trading. An ATS must be well-designed beforehand to follow the author’s exact parameters.
- Introducing Automated Trading Systems
- Breaking Down the Advantages
- Understanding the Disadvantages
What Are Automated Trading Systems?
Automated trading systems execute trades based on pre-programmed parameters that traders set up pre-deployment. The goals of an automated trading system are to:
- Automate the entry and exit points of any trade
- Remove human emotion from the trading process
- Act as a safe-guard against undisciplined traders
- Perform trades more quickly and efficiently
Investors who want to take the route of automation can use rules already established on the best entry and exit points, as well as for managing capital as the basis for their system. Common market indicators like a moving average crossover are one example of a pre-existing benchmark that can be programmed into any system.
Options like pre-written programs and software that offer many different trading strategies can also be bought from trading platforms. Investors and traders are also free to use new strategies devised with their particular goals in mind as the foundation for any automated trading algorithm.
The Upsides of Automated Trading Systems
The advantages of implementing an automated trading system include:
- Eliminating “gut” instincts and other irrational motivators from the executing of trades
- Givingtraders the ability to test (backward and forwards) the viability of the system
- Making it easier to capitalize on, or minimize the damage of sudden market changes
There are other advantages. Algorithmic trading systems can sort through market data at supercomputer speeds. They can also monitor important stock averages and trends at all times to help forestall the impact of any potential market irregularities.
The Human Element
Trading plans often take months or years of careful planning and calculation. But the faulty execution of those plans by human traders is what automatic trading systems are meant to prevent. When an algorithm takes control over the decision of when to execute a trade based on predetermined criteria the potential for human error is removed.
Testing Backwards and Forwards
Backtesting and forward-testing are two methods that allow traders to assure themselves of the viability of their investment strategy. The former is done with historical data like the past performance records of certain stocks and the history of their returns. Forward-testing involves recording the important metrics of a trade on paper to see if it will hold up to real-world conditions but without any real money involved. Backtesting and forward testing are critical to gauging the effectiveness of a trading plan before it is written into the programming of an ATS.
Traders can brace themselves against a volatile market with an automated trading system. Markets react quickly to anything that happens over a trading day, and traders who are not paying attention may not be able to act on time to prevent losses.
An automatic system can engage in protective stop-loss measures to respond to market volatility. It can close trades that move past pre-determined markers to stave off lost profits. An ATS can also do the opposite and disallow an increase in trade activity beyond a set limit to prevent traders from deviating from an investment plan.
The Downsides of an Automated Trading System
Even though applying automation to trading seems like a fool-proof plan it is not. For all the talk about removing human fallibility from the trading process, computers, algorithms, and electronic trades can all suffer from serious flaws. Among them:
- Network and Server Failures - The network upon which a pre-programmed system is deployed can suffer from sudden failures like a lost internet connection or a server that has gone down.
- Undetected Failures - Trading systems are made to automate the trading process but they too can experience anomalies that not even the most seasoned trader or programmer can anticipate, which is why the system also requires around-the-clock oversight or problems can occur.
- Too much fine-tuning - Traders or expert programmers who design and program their system can often invest too much into the infallibility of their systems, so much so that when the program goes live it fails because of over-optimization.
Bugs in the System
No one wants servers to go down or internet connections to be lost, but they happen and when they go so does a system’s ability to execute trades. Depending on when or how the system is cut-off from the mainframe, trading orders can be lost or frozen mid-transaction, which eliminates them.
Traders Need to be Vigilant
Automation can help traders keep track of important market shifts, but the system can also not detect what it was not programmed to detect. These blind spots can occur with automatic trading systems, where an algorithm will overlook a developing anomaly and not raise alarms or act preemptively to stop the anomaly from damaging trading activity.
Too Much Faith in the System
Designers of a trading strategy can often go too far in attempting to shield their plan from any potential downturns, which makes their plans vulnerable to the inescapable realities of stock market trading. Traders who design their systems only to grow in profitability overlook the fact that real-world trading does not reflect the historical data on which their plan was tested.
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Automated trading systems can help offset the uncertainty and volatility that come with instinct-based trading practices that rely on false premises. They can take time and effort to craft and test, but their benefits include streamlining the opening and closing of trades, as well as increasing trade volume.
Traders can design a system to their specifications or get a prefabricated system that can be used to test out small-scale trades. The software must work in the applicable programming language of a trading platform, which can either be customized by the trader or by an outside developer familiar with the language. Automation does not mean traders can take their hands off the wheel. They must remain stay-on top of daily trading activity to make sure the program stays on course with the determiners programmed into it.