Automated trading, also known as algorithmic trading or system trading has become a common practice nowadays. About 75% of shares traded on U.S. stock exchanges come from auto-trading. It is a technology-generated trading system that uses algorithms as a predefined set of instructions to buy and sell financial holdings. In this article, Handy discusses the pros and cons of the automated trading system.
The positive aspects of the automated trading system are listed below:
- Less stress and more time- When you’re using the auto-trading system and trade rules have been met, the process of trading is automated from then on. Thus, it leaves no room for a trader to hesitate and think over and over again regarding a trade, making the process of trading less stressful.
At the same time, auto-trading reduces the amount of daily work for a trader drastically. Since the system does most of the work, you have more time in your hand to engage yourself in other things.
- Increased speed and accuracy- Computers respond immediately to changing market conditions. Thus, automated trading systems are able to generate an order as soon as trading criteria are fulfilled. Again, since there is minimum human intervention in auto-trading, there is much less room for error. The algorithms are checked and rechecked as a part of technology and thus, they do not get affected by human errors.
- Preserves discipline and consistency- Trading discipline is often lost due to emotional factors- be it a fear of taking the risk or fancy to profit a little more than the usual. Most of the time, such a lack of discipline has a negative impact on the outcome of a trade. The auto-trading system, as opposed to it, helps to preserve consistency in trading experience.
- Back testing- The automated trading system helps a trader to test whether a strategy will work or not. Based on historical data with absolute commands, back testing enables traders to evaluate and refine a trading idea, and to determine the system’s expectancy- for example, the average amount of profit or loss per unit of risk.
Now, let’s look at the cons of auto-trading:
- Complete dependence on technology- In reality, auto-trading is not simply about setting up instructions and then watching trading being accomplished automatically. Due to its complete dependence on technology, the auto-trading process cannot be completed in issues such as loss of internet connection, network crash, computer or server problems, and so on.
- Over-optimization- Trading plans often tend to become unreliable in the current market. Despite being based upon historical data and particular assumptions, some optimized trading plans fail immediately in the live market due to their impractical assumptions and incorrect execution methods.
- Need for constant monitoring- Although the computer does most of the work in auto-trading, it requires constant monitoring from our end. You simply cannot leave for the day by turning on the computer. You need to check consistently for issues such as whether the connection to the server is active or not, if there are any duplicate or canceled orders, etc.
- Loss of human control- Technology cannot understand the underlying change in the situation of the market as human minds do. When using auto-trading, it becomes impossible for us to intervene and make a necessary change in an ongoing trade.
We cannot deny the effectiveness of the auto-trading system in the stock market these days but at the same time, the negative aspects of it shouldn’t be overlooked. Handy suggests you have some firsthand trading experience before using an automated trading system so that you can utilize it properly.