Automated trading systems used to be reserved only for institutional traders, but they have made their way into the retail trader’s toolbox, as well. These algorithmic-based mechanical trading systems allow traders to specify the precise conditions under which to enter and exit a trade, removing human error (assuming they’re programmed correctly).
While automation might seem to be an obvious good, there are both pros and cons to automated trading systems. Here’s a look at the ones to keep in mind before you decide to automate your trades.
- You can backtest your trade strategy on historical market data to see if it does what you want it to do. This is also helpful in predicting returns once you implement a plan you’ve tested.
- The market is driven by emotion, but automated trading systems take the emotion out of your trading decisions. That is especially helpful if you’re the type of trader who has a hard time following your own trading strategy.
- Similarly, automated trading systems enforce discipline, especially in a volatile market. Traders, even experienced ones, can be lured into keeping a position open longer than prudence requires, in an effort to squeeze out a little extra profit or recoup an uncomfortable loss. If you’ve let emotion override discipline, you know how disastrous this can be.
- These systems virtually eliminate order entry error and speed up the order process. This is especially helpful for day traders.
- You can diversify your trading by implementing multiple strategies across multiple accounts and instruments. Automated systems can manage far more than their human trader counterparts.
- Automated trading systems are generally linked to a direct access broker, which requires programming based on that broker’s specific platform. Some platforms have built-in “wizards” to build a plug-and-play trading strategy, but these are often insufficient for a trader’s needs. Unless you’re very comfortable developing your own software, you’ll need to work with a programmer, which brings its own set of problems, including cost and bugs, since the program will be untested.
- Backtesting is a great idea in theory, but too often, a trader will develop a plan that is optimized based on historical data. This extraordinarily fine-tuned plan results in profitable trades nearly all the time in backtesting but is an absolute disaster once it’s applied to a live market. It’s always a good idea to stick to low-value trades while you iron out the flaws in your automated trading plan.
- You still need to monitor your automated trading system; it’s not something you set and forget. Many things can go wrong—connectivity issues, a computer crash, even irregularities in the market that aren’t factored into your trading plan.
If you opt to buy an off-the-shelf system, keep in mind that many are designed to work best in certain markets or with certain trading strategies. Do your research and check reviews and testimonials before you buy. Know that the automated trading systems market is rife with scams, so buyer beware.