Introduction to Automated Trading
What is Automated Trading?
Automated trading or algorithmic trading refers to the combination of hardware and software in order to create computer systems capable of autonomously generating trading orders and automatically submit them to the market without any human intervention. These automated computer systems can automatically open, modify, and close trading positions on a 24/7 basis.
Automated trading systems can automate the whole trading process, from the trading decision to market execution. The enormous multi-tasking power of these systems allows the simultaneous analysis of hundreds of financial markets. Moreover, an automated system has no emotions and can trade 24/7 without feeling stress or fatigue. All these advantages make the creation of a successful automated trading system the ‘holy grail’ for any ambitious trader.
The Holy Grail of Trading
Since the new millennium, automated trading is witnessing significant growth. The implementation of automated trading strategies has become a common practice for both professional and retail traders. Furthermore, building an automated trading system is easier and cheaper than ever.
Institutional and Retail Traders
Institutional traders use a wide variety of sophisticated automated systems. According to the Bank of England (2017), there are two mega-trends. On the one side, there are large advances in data-driven modeling techniques that combine computational statistics, mathematical optimization, pattern recognition, predictive analytics, and artificial intelligence. On the other side, there is a rapidly increasing amount of granular data, often referred to as Big Data.
Retail traders apply automated strategies based on Expert Advisors (EAs) running on four trading platforms: MetaTrader-4, MetaTrader-5, TradeStation, and NinjaTrader. These EAs can analyze the market 24/7 and create trading signals based mainly on technical analysis. Their algorithms can spot trading opportunities based on price movements and their products (volatility, strong trends, reversals, etc.). For risk management and position sizing, these EAs incorporate basic money management techniques.
The Basics of Automated Trading
Automated trading is a method of trading the global financial markets based on a combination of computer software and hardware. Automated trading is a sophisticated branch of systematic trading and all automated trading systems are systematic.
Major Assumptions of Systematic Trading
Systematic trading assumes the following:
The existence of a rules-driven trading strategy that is based on objectively reproducible (computable) inputs
The application of that strategy with discipline and outside of the human emotional context
When we refer to automated trading, we refer to the way that trading orders are actually executed. An automated trading system must be able to execute trades without human intervention by placing also limit orders (usually a take-profit and a stop-loss).
General Categories of Automated Trading
According to Mitra, di Bartolomeo, and Banerjee (2011), automated trading can be divided into five (5) main categories:
(i) Algorithmic Executions
Opening and closing speculative positions based on mathematical algorithms.
(ii) Statistical Arbitrage
Statistical arbitrage trading, which is based on the automation of the investment decision process.
(iii) Crossing Transactions
A financial market participant seeks a counterparty to be the other side of the trade, without exposing the existence of the order to the general population of market participants.
(iv) Electronic Liquidity Provision
Willing to buy or sell any asset upon counterparty request, electronic liquidity providers differ from traditional market makers in that they often do not openly identify the set of assets in which they will trade.
(v) Predatory Trading
Typically placing thousands of simultaneous orders into a market while expecting to execute only a tiny fraction of all orders. This “place and cancel” process has two purposes. The first is an information gathering process. By observing which orders execute, the predatory trader expects to gain knowledge of the trading intentions of larger market participants such as institutional asset managers. Such asymmetric information can then be used to advantage in the placement of subsequent trades. A second and even more ambitious form of predatory trading is to place orders so as to artificially create abnormal trading volume or price trends in particular security so as to purposefully mislead other traders and thereby gain an advantage.
Advantages & Disadvantages of Automated Trading
Major Advantages of Automated Trading
The greatest advantage of automated trading is that it is able to minimize emotions throughout the trading process. The emotional character of our human nature is highly disturbing our decision-making process when we trade in any financial market. Fear, hyper-optimism and other similar feelings deriving from the emotional part of our brain are working against logic and finally against the odds of winning. This emotional part is the worst trader there is.
Manual trading has limitations regarding the stamina of our human nature. An automated trading system never gets tired. Using a VPS hosting service you can turn off your PC and continue trading 24hours per day.
Automated trading offers the ability to easily and quickly backtest any trading idea. It is very difficult to backtest manual trading strategies.
Automated trading systems are also able to analyze simultaneously multiple financial markets, and take advantage of trading opportunities in much shorter reaction time.
Major Disadvantages of Automated Trading
The greater disadvantage of an automated trading system is that it can deal only the market conditions that it is programmed to deal with. That means that new market conditions deriving from major fundamental changes cannot be interpreted and incorporated.
A major event, such as a country’s default to meet its payments, usually leads to extreme volatility in the market, and extreme volatility can change everything. Semi-automatic systems may adapt better to new market conditions, as they can be re-adjusted anytime.
In addition, some experts argue that auto-trading systems are inefficient because they create trading signals based on backward-looking indicators
■ What is Automated Trading
George Protonotarios, financial analyst
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