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Newbie traders often incur significant losses, with numerous culprits to blame. As a newbie, emotions like greed may get the best of you and encourage you to make impulsive decisions that magnify potential losses. To make matters worse, since you lack adequate experience, you may try to recoup your losses by overtrading, which is highly guaranteed to worsen the situation.
Having said that, we have some good news. You can use automated trading solutions to curb losses often catalysed by issues like emotional decision-making and overtrading. We’ve broken down the fundamentals of automated trading below.
In This Guide
What is Automated Trading?
Automated trading goes by different names, including auto trading and algorithmic. These concepts refer to a trading strategy that involves using special software programs to execute financial trades based on predetermined rules.
Richard Donchian, an infamous American trader and renowned pioneer in the field of managed futures, introduced automated trading in 1949. This legend introduced the first publicly managed futures funds that relied on a rule-based, systematic trading strategy. This concept made a groundbreaking contribution to what we know as automated trading today.
There are many types of automated trading today, including:
- High-frequency trading: High-frequency trading relies on powerful systems and algorithms designed to execute a vast volume of orders at phenomenally high speeds. HFT is ideal for institutional traders who wish to capitalize on minute market inefficiencies and price discrepancies.
- Copy trading: This solution allows beginners and novices to copy the trades of the most successful or experienced traders automatically. If you have yet to understand automated trading and how to develop custom strategies, start your journey with copy trading.
- Signal-based trading: In signal-based automated trading, algorithms use predefined signals to execute trades. The signals are often based on diverse factors, including market news, price patterns, and technical indicators.
- Trend following: When using this strategy, algorithms will help you assess market data and isolate trends from which you can profit. In most cases, trend-following systems identify assets in an uptrend and downtrend and automatically execute buy and sell orders, respectively.
- Mean reversion: As the name implies, this automated strategy relies on a popular concept called mean reversion. It stipulates that asset prices are highly likely to return to average levels after an extreme shift.
How does Automated Trading Work?
In summary, automated trading solutions use specially designed computer algorithms to execute trades automatically in different financial markets, eliminating the need for human intervention.
Here’s an extensive breakdown of how automated trading works:
- Strategy development
Before automated trading kicks in, the trader creates specific rules and parameters that the algorithm will use to execute trades automatically. These elements help the trading software make the best decisions based on aspects like historical price patterns, technical indicators, and market conditions. Then, the trader uses the right programming language to code the entire strategy into a usable program.
If you are a beginner and have yet to become an expert software coder, don’t worry. You can skip manual strategy development by choosing pre-built automated trading strategies and algorithms. Additionally, you can avoid this task through automated copy or social trading.
- Backtesting
Backtesting refers to using historical data to gauge a trading algorithm’s effectiveness and performance. In other words, once you have what seems like a fitting strategy, the next thing to do is test how profitable or risky it is using past price movements.
While backtesting, you have to analyzed crucial performance metric like the percentage of successful trades and the total loss/profit after all trades. Then, use the data to fine-tune your algorithm and enhance its performance.
- Setting up
Automated software must be connected to a trading platform to work effectively. So, after fine-tuning your solution, pick a reputable platform that supports auto trading and link the two. There are many incredible platforms that support auto trading, from TradingView and cTrader to MetaTrader 4 and MetaTrader 5.
Since security is paramount in online trading, ensure that the platform you choose to connect your automated software is licensed by the FCA in the UK. It should also have the financial products you wish to trade and have an excellent online reputation. Use Trustpilot, Google Play, and the App Store to gauge every platform’s reputation and track record before committing.
- Market monitoring
To attain maximum success, automated trading software must monitor financial markets closely in real time. It must keep up with different aspects, especially price movements and market conditions. Since such elements can change rapidly, every automated trading solution must implement real-time monitoring for prompt response.
In addition to the aspects we’ve mentioned, the best automated trading systems monitor a user’s account balance, the performance of all open positions, and realised/unrealised profits. They also keep their users informed with timely, relevant alerts and notifications.
- Trade execution
After the predetermined parameters trigger a signal, the automated trading system sends an order to the connected trading broker. The latter then executes the trade promptly. Automated trading solutions execute traders as soon as the pre-specified market conditions are met. These systems can also set stop-loss/take-profit levels and adjust every trade’s size based on key risk management parameters.
How to Get Started with Automated Trading
Having learnt the fundamentals of how to automate trading and how automated trading systems work, it’s time to discuss how to get started with this strategy. Here’s how you can dive in and reap amazing perks today:
Step 1: Educate Yourself
Step 2: Pick a Reputable Trading Platform and Broker
Step 3: Choose or Develop a Trading Strategy
Step 4: Use Paper Trading to Test Your Strategy
Step 5: Deploy Your Automated Trading Strategy
We’ve focused more on covering the fundamentals of automated trading for beginners. Consequently, the information in this guide is primarily meant to help you get a foot in the door. To ascend to the next level and become formidable at auto trading, you must seek other resources, like free online courses, and use them to increase your knowledge base.
While educating yourself, don’t forget about the most crucial concepts. For instance, study different types of automated trading and their upsides and risks keenly. Additionally, further your understanding of key elements like market structure and technical analysis.
With adequate education under your belt, search for a good trading platform that supports algorithmic trading, like MT4 and MT5. You should also find a broker that offers your preferred auto trading platform and supports automated trading.
While finding the perfect broker, vet all UK service providers based on key factors like regulatory status, security, and reputation. To summarize, choose a broker that is regulated by the FCA, employs industry-standard security protocols like advanced data encryption, and boasts excellent reviews and ratings. Then, open, verify, and fund your trading account.
After choosing the best trading platform and broker, you can either build your system or search for a fitting pre-build strategy. Building a custom strategy should be a top priority if you have the technical know-how. Why? This project will enable you to tailor each strategy to align perfectly with your trading style and goals.
If you don’t have sufficient knowledge or time to build a custom automated trading strategy, go with pre-built solutions. Before using any pre-built strategy, check its track record. Don’t forget to backtest all your strategies to avoid nasty surprises.
Backtesting lets you assess a trading strategy’s performance based on historical data. That said, historical data don’t always reflect current conditions in different financial markets. An automated strategy can perform excellently during backtesting and flop magnificently in live market conditions.
To avoid costly disappointments, use paper trading to test each automated strategy’s performance in real market conditions. You’ll be using virtual funds, so don’t worry about incurring devastating losses. And, if you identify weaknesses that didn’t manifest during backtesting, fine-tune your strategy accordingly.
If your strategy performs spectacularly during backtesting and paper trading, you can transition from the simulated environment to live trading. Since live trading is risky, remember to define risk parameters like position sizing and stop-loss/take-profit levels clearly. Also, spread risk at all times by ensuring diverse assets are in your portfolio.
We highly recommend allocating a small amount of money to each trade when introducing your strategy to live market conditions. That way, you can gauge its effectiveness and performance without risking major financial setbacks. Also, keep a close eye on each strategy to ensure you identify and address anomalies promptly before they cause havoc to your capital and overall portfolio.
Pros & Cons of Automated Trading
Trading with automated solutions comes with several advantages and disadvantages. Here’s a comprehensive view of these elements:
Pros:
- Since automated trading relies on algorithms and predefined systems, they are impervious to emotional bias. In other words, you can prevent emotions like greed and fear from undermining decision-making through auto trading.
- Maintaining discipline and sticking to your plans can be challenging to a human trader, especially when trades don’t go your way. Fortunately, you can use automated trading solutions to remain consistent and not deviate from your plans.
- Auto trading systems can assess market data and open trades faster than humans. In doing so, they help you capitalize on most market opportunities and maximize potential returns.
- Trading algorithms can run 24/7 without getting tired. This quality enables them to seamlessly identify and leverage financial opportunities in different global markets and time zones.
Cons:
- Like all artificial solutions, automated trading systems are susceptible to issues like software bugs. These can lead to erroneous moves, missed opportunities, and hefty losses.
- Since algo trading solutions are tailored to follow predetermined parameters and rules, they often have a hard time adapting when market conditions change unexpectedly.
Automated Trading Risks in the UK
Besides the pros and cons we’ve covered in the previous section, automated trading has numerous risks. For starters, you may overfit a strategy to perform exquisitely based on historical data. This issue will eventually undermine the system’s ability to adapt to new market conditions and cause extensive losses on your part.
What’s more, as a novice, you may fail to deploy an automated trading strategy with proper risk management protocols. That will force you to monitor all trades closely. Otherwise, you’ll be risking significant financial drawdowns.
Lastly, your automated trading system may fail to seamlessly integrate with your preferred trading platform or service provider. This can facilitate complications that might cause extensive losses, like execution errors.
FAQs
Is automated trading a good idea?
Automated trading might be a good idea, depending on your trading goals and preferences. However, the perks of using auto trading are worth considering, from consistency to elimination of emotional bias.
Is automated trading profitable?
Automated trading can be profitable. However, whether or not you profit from it will depend on multiple factors, including how effective your trading strategy is and your dedication to managing risk.
What is an example of automated trading?
Here’s an example of automated trading. A trader may design an automated system that, based on predetermined rules, buys and sells specific company shares when their prices drop below or rise above a certain point.
How to develop an automated trading system?
To develop an effective automated trading system, you must first create a strategy that aligns with your trading style and objectives. Then, code the system with a programming language you’re familiar with, backtest it with historical data, and make the necessary adjustments.
Conclusion
Countless traders are reaping handsome returns from online trading, all thanks to automated strategies. But the opposite is also true. Thousands of traders struggle to earn consistent returns, even with auto trading in their arsenal. You can profit from or lose money to automated trading depending on your actions and decisions.
To ensure you attain maximum success and avoid frequent losses, backtest every automated trading system before using it in live trading. You should also monitor your strategy’s performance regularly while keeping in mind that algorithmic trading systems aren’t infallible. If you notice any pertinent issues, fix them before the entire situation turns into a financial catastrophe.
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