Automated Trading Systems: The Pros and Cons (2023)

What Is an Automated Trading System?

Automated trading systems — also referred to as mechanical trading systems, algorithmic trading, automated trading or system trading — allow traders to establish specific rules for both trade entries and exits that, once programmed, can be automatically executed via a computer. In fact, various platforms report 70% to 80% or more of shares traded on U.S. stock exchanges come from automatic trading systems.

Traders and investors can turn precise entry, exit, and money management rules into automated trading systems that allow computers to execute and monitor the trades. One of the biggest attractions of strategy automation is that it can take some of the emotion out of trading since trades are automatically placed once certain criteria are met.

The trade entry and exit rules can be based on simple conditions such as a moving average crossover or they can be complicated strategies that require a comprehensive understanding of the programming language specific to the user's trading platform. They can also be based on the expertise of a qualified programmer.

Automated trading systems typically require the use of software linked to a direct access broker, and any specific rules must be written in that platform's proprietary language. The TradeStation platform, for example, uses the EasyLanguage programming language. On the other hand, the NinjaTrader platform utilizes NinjaScript. The figure below shows an example of an automated strategy that triggered three trades during a trading session.

Automated Trading Systems: The Pros and Cons (1)

A five-minute chart of the ES contract with an automated strategy applied.

Establishing Trading "Rules"

Some trading platforms have strategy-building "wizards" that allow users to make selections from a list of commonly available technical indicators to build a set of rules that can then be automatically traded. The user could establish, for example, that a long position trade will be entered once the 50-day moving average crosses above the 200-day moving average on a five-minute chart of a particular trading instrument. Users can also input the type of order (market or limit, for instance) and when the trade will be triggered (for example, at the close of the bar or open of the next bar), or use the platform's default inputs.

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Many traders, however, choose to program their own custom indicators and strategies. They will often work closely with the programmer to develop the system. While this typically requires more effort than using the platform's wizard, it allows a much greater degree of flexibility, and the results can be more rewarding. Just like anything else in the trading world, there is, unfortunately, no perfect investment strategy that will guarantee success.

Once the rules have been established, the computer can monitor the markets to find buy or sell opportunities based on the trading strategy's specifications. Depending on the specific rules, as soon as a trade is entered, any orders for protective stop losses, trailing stops and profit targets will be automatically generated. In fast-moving markets, this instantaneous order entry can mean the difference between a small loss and a catastrophic loss in the event the trade moves against the trader.

Advantages of Automated Systems

There is a long list of advantages to having a computer monitor the markets for trading opportunities and execute the trades, including:

MinimizingEmotions

Automated trading systems minimize emotions throughout the trading process. By keeping emotions in check, traders typically have an easier time sticking to the plan. Since trade orders are executed automatically once the trade rules have been met, traders will not be able to hesitate or question the trade. In addition to helping traders who are afraid to "pull the trigger,"automated trading can curb those who are apt to overtrade — buying and selling at every perceived opportunity.

Backtesting

Backtesting applies trading rules to historical market data to determine the viability of the idea. When designing a system for automated trading, all rules need to be absolute, with no room for interpretation. The computer cannot make guesses and it has to be told exactly what to do. Traders can take these precise sets of rules and test them on historical data before risking money in live trading. Careful backtesting allows traders to evaluate and fine-tune a trading idea, and to determine the system's expectancy – i.e., the average amount a trader can expect to win (or lose) per unit of risk.

Preserving Discipline

Because trade rules are established and trade execution is performed automatically, discipline is preserved even in volatile markets. Discipline is often lost due to emotional factors such as fear of taking a loss, or the desire to eke out a little more profit from a trade. Automated trading helps ensure discipline is maintained because the trading plan will be followed exactly. In addition, "pilot error" is minimized. For instance,if an order to buy 100 shares will not be incorrectly entered as an order to sell 1,000 shares.

One of the biggest challenges in trading is to plan the trade and trade the plan. Even if a trading plan has the potential to be profitable, traders who ignore the rules are altering any expectancy the system would have had. There is no such thing as a trading plan that wins 100% of the time. After all, losses are a part of the game. But losses can be psychologically traumatizing, so a trader who has two or three losing trades in a row might decide to skip the next trade. If this next trade would have been a winner, the trader has already destroyed any expectancy the system had. Automated trading systems allow traders to achieve consistency by trading the plan.

Improving Order Entry Speed

Since computers respond immediately to changing market conditions, automated systems are able to generate orders as soon as trade criteria are met. Getting in or out of a trade a few seconds earlier can make a big difference in the trade's outcome. As soon as a position is entered, all other orders are automatically generated, including protective stop losses and profit targets. Markets can move quickly, and it is demoralizing to have a trade reach the profit target or blow past a stop-loss level – before the orders can even be entered. An automated trading system prevents this from happening.

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Diversifying Trading

Automated trading systems permit the user to trade multiple accounts or various strategies at one time. This has the potential to spread risk over various instruments while creating a hedge against losing positions. What would be incredibly challenging for a human to accomplish is efficiently executed by a computer in milliseconds. The computer is able to scan for trading opportunities across a range of markets, generate orders and monitor trades.

Drawbacks of Automated Systems

Automated trading systems boast many advantages, but there are some downfallsand realities traders should be aware of.

Mechanical Failures

The theory behind automated trading makes it seem simple: Set up the software, program the rules and watch it trade. In reality, automated trading is a sophisticated method of trading, yet not infallible. Depending on the trading platform, a trade order could reside on a computer, not a server. What that means is that if an internet connection is lost, an order might not be sent to the market. There could also be a discrepancy between the "theoretical trades" generated by the strategy and the order entry platform component that turns them into real trades. Most traders should expect a learning curve when using automated trading systems, and it is generally a good idea to start with small trade sizes while the process is refined.

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Monitoring

Although it would be great to turn on the computer and leave for the day, automated trading systems do require monitoring. This is because of the potential for technology failures, such as connectivity issues, power losses or computer crashes, and to system quirks. It is possible for an automated trading system to experience anomalies that could result in errant orders, missing orders or duplicate orders. If the system is monitored, these events can be identified and resolved quickly.

Over-Optimization

Though not specific to automated trading systems, traders who employ backtesting techniques can create systems that look great on paper and perform terribly in a live market. Over-optimization refers to excessive curve-fitting that produces a trading plan unreliable in live trading. It is possible, for example, to tweak a strategy to achieve exceptional results on the historical data on which it was tested. Traders sometimes incorrectly assume a trading plan should have close to 100% profitable trades or should never experience a drawdown to be a viable plan. As such, parameters can be adjusted to create a "near perfect" plan — that completely fails as soon as it is applied to a live market.

Avoid the Scams

While you search for your preferred system, remember: If it sounds too good to be true, it probably is. There are a lot of scams going around. Some systems promise high profits all for a low price. So how do you tell whether a system is legitimate or fake? Here are a few basic tips:

  1. Scrutinize anything you'd have to pay for before you pay or lay down any money for a trading account and always ask questions. If you don't, you may lose money in the end.
  2. Do your research and make sure you know everything about the system in question. And be sure to read the terms and conditions before you commit.
  3. Are there any testimonials you can read? Check third-party sites or even financial regulatory sites for reviews.
  4. Does the system come with a trial period? A lot of scam sites won't offer you a trial.

Server-Based Automation

Traders do have the option to run their automated trading systems through a server-based trading platform. These platforms frequently offer commercial strategies for sale so traders can design their own systems or the ability to host existing systems on the server-based platform. For a fee, the automated trading system can scan for, execute and monitor trades, with all orders residing on the server. This often results in potentially faster, more reliable order entries.

Before you Automate

The word "automation" may seem like it makes the task simpler, but there are definitely a few things you will need to keep in mind before you start using these systems.

Ask yourself if you should use an automated trading system. There are definitely promises of making money, but it can take longer than you may think. Will you be better off to trade manually? After all, these trading systems can be complex and if you don't have the experience, you may lose out.

Know what you're getting into and make sure you understand the ins and outs of the system. That means keeping your goals and your strategies simple before you turn to more complicated trading strategies.

And remember, there is no one-size-fits-all approach. You will need to figure out your preferred strategy, where you want to apply it and just how much you want to customize to your own personal situation. All of that, of course, goes along with your end goals

(Video) Automated Trading: Pros and Cons

The Bottom Line

Although appealing for a variety of reasons, automated trading systems should not be considered a substitute for carefully executed trading. Technology failures can happen, and as such, these systems do require monitoring. Server-based platforms may provide a solution for traders wishing to minimize the risks of mechanical failures. Remember, you should have some trading experience and knowledge before you decide to use automated trading systems.

FAQs

Is automated trading a good idea? ›

Not only does automated trading save people time and money but it also has the potential to boost profits by taking emotions out of the decision-making process. Of course, many still use traditional manual techniques for everyday trading and investing.

What are the benefits of automated trading? ›

Advantages of Automated Systems
  • Minimizing Emotions. Automated trading systems minimize emotions throughout the trading process. ...
  • Backtesting. ...
  • Preserving Discipline. ...
  • Improving Order Entry Speed. ...
  • Diversifying Trading. ...
  • Mechanical Failures. ...
  • Monitoring. ...
  • Over-Optimization.

What is a limitation of the automated trading system? ›

Some trading systems will reside on your computer – and not a server. This means that if an internet connection is lost, an order might not be sent to the market. There is also the potential for a power loss, computer crash, or some other system quirk that could stop your algorithm from running or cause an anomaly.

Which automated trading platform is best? ›

Best Automated Platforms for 2022 Ranked

eToro Copy Trading - Auto-trade Stocks, Crypto, Forex, & More. Bitcoin Prime - Best Automated Crypto Trading Software. NFT Profit - Best Auto Trading Platform for NFTs. TeslaCoin - Top New Automated Trading System.

Can you make money with automated trading? ›

Yes! Algorithmic trading is profitable, provided that you get a couple of things right. These things include proper backtesting and validation methods, as well as correct risk management techniques. Unfortunately, many never get this completely right, and therefore end up losing money.

Is automated trading better than manual? ›

For the advanced level traders, manual trading is the best; for beginners, automated trading is the best. Manual trading puts traders in real-world scenarios, allowing them to make more informed trading decisions and gain trading experience. Technical and fundamental analysis become second nature to a trader.

Who uses automated trading? ›

Algorithmic trading is mainly used by institutional investors and big brokerage houses to cut down on costs associated with trading. According to research, algorithmic trading is especially beneficial for large order sizes that may comprise as much as 10% of overall trading volume.

What is fully automated trading? ›

Automated Trading, also known as algorithm trading or mechanical trading system, uses automated trading software backed by algorithms to execute trading orders at high speed. Investors and traders use trading software and feed it pre-programmed trading instructions based on time, volume, and price.

Is automated trading Legal? ›

Yes, algorithmic trading is legal, but some people do have their objections to how automated trading can impact the markets. While their concerns may be legitimate, there are no rules or laws in place that keep retail traders from making use of trading algorithms.

What are the disadvantages of algorithmic trading? ›

Disadvantages of Algo Trading
  • Knowledge of the programming language- Formulating complex algorithms requires extensive know-how of coding software such as C+, C++, Java, Python, R, etc. ...
  • Dependence on technology - Faulty algorithms have the potential to result in insurmountable losses for the trader.

What is a good expectancy for a trading system? ›

Good trading expectancy represents any positive expectancy ratio above 0.25. This means If you risk $100, you expect to earn $25 profit (0.25 * $100 = $25). Usually, traders consider that 0.25 R, where R is risk in dollars, is a good trading expectancy in live trading.

How do you do automated trading? ›

How does automated trading work? First, you will choose a platform and set the parameters of your trading strategy. You'll use your trading experience to create a set of rules and conditions, and then your custom algorithm will apply the criteria to place trades on your behalf.

What percentage of trades are automated? ›

According to Wall Street data, Algorithmic trading accounts for around 60-73% of the overall US equity trading. As per Select USA, the US financial markets are the largest and most liquid globally.

How much does trade algo cost? ›

We offer a traditional SAAS software “freemium” business model. Potential customers typically receive a free demo of our platform before licensing an annual subscription. Our general annual subscription cost for our premium real time data tier is between $99 per month and $416 per month.

What tools are used in algo trading? ›

Algo trading with R or Python

These computer languages offere plenty libraries, modules, or packages for all sorts of data analysis tasks, including broker connections, machine learning, optimization, and backtests. Since they are not limited to trading, they can be used for research and analysis of any sort.

Why do you need 25k to day trade? ›

You need a minimum of $25,000 equity to day trade a margin account because the Financial Industry Regulatory Authority (FINRA) mandates it. The regulatory body calls it the Pattern Day Trading Rule.

Can I make a living as a day trader? ›

Can you make money day trading? Most of the time, day trading is not profitable, but it can be profitable. Investors sometimes succeed at predicting a stock's movements and raking in six-figure profits by accurately timing the market.

Do trading robots work? ›

While most forex robots do 'work' in the sense that they are programmed to automatically carry out trades, unfortunately, they are not foolproof so they cannot provide any guarantee of long-term profits. At best, they are a useful tool which can be used by forex traders to help make informed trading decisions.

What is an AI trading system? ›

AI stock trading uses robo-advisors to analyze millions of data points and execute trades at the optimal price. AI traders also analyze forecast markets with greater accuracy and trade firms efficiently which mitigate risks and provide higher returns.

Is algo trading safe? ›

Algo trading is safe when you have a proper understanding of the systems, markets, trading strategies, and coding skills.

When did automated trading Start? ›

The concept of automated trading system was first introduced by Richard Donchian in 1949 when he used a set of rules to buy and sell the funds. Then, in the 1980s, the concept of rule based trading became more popular when famous traders like John Henry began to use such strategies.

Why does algo-trading fail? ›

The Biggest Risk: Amplification of Systemic Risk

The speed at which most algorithmic high-frequency trading takes place means one errant or faulty algorithm can rack up millions in losses in a short period.

Is algorithmic trading the future? ›

Future of Algorithmic Trading

Algorithmic trading is transformative in many ways - apart from profit opportunities for the trader, the algorithm makes trading more systematic by ruling out the impact of human emotions and errors on trading activities.

How do you program a trading system? ›

Success Roadmap: 5 Steps to Create a Trading Algorithm
  1. Step 1: Create a Trading Platform. ...
  2. Step 2: Develop and Visualize Your Trading Algorithm Strategy. ...
  3. Step 3: Define Time Frame and Trading Frequency. ...
  4. Step 4: Test the Trading Algorithm on Historical Data. ...
  5. Step 5: Connect Algorithm To a Live Demo Trading Account.
14 Dec 2021

Who invented electronic trading? ›

E-Trade
Logo since January 1, 2022
TypeSubsidiary
IndustryFinancial services
Founded1982 Palo Alto, California, U.S.
FoundersWilliam A. Porter Bernard A. Newcomb
5 more rows

What is a system trading? ›

In system trading, the decision to make a trade is based entirely on the trading system. System trading decisions are absolute. They do not offer the opportunity to decline to make a trade, based on the trader's discretion. If the criteria are met, the trade is taken.

What are the risks of high-frequency trading? ›

Risks of High-Frequency Trading

High-frequency traders rarely hold their portfolios overnight, accumulate minimal capital, and establish holding for a short timeframe before liquidating their position. As a result, the risk-reward, or Sharpe Ratio, is exceptionally high.

Do algorithms control the stock market? ›

You've likely heard the term “algorithms” or (algos for short) used in reference to trading. Algorithms run the markets and are responsible for most of the trading volume in the U.S. stock markets on any given trading day.

Which strategy is best for algo-trading? ›

Any good strategy for algorithm trading must aim to improve trading revenues and cut costs of trading. The most popular strategies are arbitrage, index fund rebalancing, mean reversion, and market timing. Other strategies are scalping, transaction cost reduction, and pairs trading. `

What is a good profit factor in trading? ›

The profit factor is a mathematical metric that divides the gross profits by the gross losses. A good profit factor in trading is above 1.75.

How do you calculate the edge of a trade system? ›

This is my formula: Strategy + Rules = Trading Edge

The human brain tends to understand the idea of supply and demand on a one-to-one level.

What is a profit factor? ›

Profit Factor

The profit factor is defined as the gross profit divided by the gross loss (including commissions) for the entire trading period. This performance metric relates the amount of profit per unit of risk, with values greater than one indicating a profitable system.

How do you automate stock to buy? ›

One of the best ways to automate your investments is through a low-cost index fund that tracks a stock market index like the S&P 500. Most brokers will allow you to set up an automatic investment plan for funds you own in your brokerage, retirement, 529 plans, and other accounts.

What is the difference between algo-trading and auto trading? ›

As discussed, algorithmic trading is used to buy and sell large amounts of assets while minimizing transaction costs and increasing speed. These systems only execute the provided orders. Conversely, automated trading software involves the complete automation of the trading process.

How long does it take to learn algorithmic trading? ›

6 month comprehensive course on Algorithmic Trading with certification
Course FeaturesExecutive Programme in Algorithmic Trading (EPAT)
Course duration6 months via weekend lectures
Course modules14 modules
Faculty members15+
Part-timeYes
30 more rows
25 Jul 2018

Who is controlling the stock market? ›

The stock market is regulated by the U.S. Securities and Exchange Commission, and the SEC's mission is to “protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation."

Do investment banks use algorithmic trading? ›

Algorithmic trading is dominated by large trading firms, such as hedge funds, investment banks, and proprietary trading firms.

How much does an algorithmic trader make? ›

How much does an Algorithmic Trader make in the United States? The average Algorithmic Trader salary in the United States is $53,800 as of October 27, 2022, but the salary range typically falls between $50,213 and $55,658.

How difficult is algorithmic trading? ›

While algo trading may seem easy, it is quite difficult to set up and maintain. It requires the algo trader to do a lot of market research to find some trading edges, code algorithms to take advantage of the trading edges, backtest the strategies, test them for robustness, and launch them to trade.

Which language is best for algo trading? ›

Java is one of the most sought-after programming languages for traders. Data modeling, simulations, and low latency execution are some of the many areas where Java serves to be no less than a blessing.

What language are trading bots written in? ›

Python is a high-level language used for automated trading and preferred by HFTs. It has free open-source libraries and tools that facilitate bot coding and fast transactions.

Is automated trading illegal? ›

Yes, algorithmic trading is legal, but some people do have their objections to how automated trading can impact the markets. While their concerns may be legitimate, there are no rules or laws in place that keep retail traders from making use of trading algorithms.

Is automated stock trading legal? ›

Are Trading Bots Legal? Yes, it's legal to use trading bots. Although some people do have their objections to how automated trading impacts the markets, there are no rules or laws in place that keep retail traders from using trading bots.

Can I automate my trading with Zerodha? ›

While you can build your own algorithm and deploy it to generate buy or sell signals, Manual intervention is needed for placing orders as full automation is not permitted for retail traders. Traders who want to use this facility but are unaware of coding and technical jargon can use Streak by Zerodha.

How do I start automated trading? ›

How does automated trading work? First, you will choose a platform and set the parameters of your trading strategy. You'll use your trading experience to create a set of rules and conditions, and then your custom algorithm will apply the criteria to place trades on your behalf.

When did automated trading Start? ›

The concept of automated trading system was first introduced by Richard Donchian in 1949 when he used a set of rules to buy and sell the funds. Then, in the 1980s, the concept of rule based trading became more popular when famous traders like John Henry began to use such strategies.

What percentage of trades are automated? ›

According to Wall Street data, Algorithmic trading accounts for around 60-73% of the overall US equity trading. As per Select USA, the US financial markets are the largest and most liquid globally.

How much of the stock market is bots? ›

In the U.S. stock market and many other developed financial markets, about 60-75 percent of overall trading volume is generated through algorithmic trading according to Select USA.

Can I use AI for trading? ›

AI stock trading uses robo-advisors to analyze millions of data points and execute trades at the optimal price. AI traders also analyze forecast markets with greater accuracy and trade firms efficiently which mitigate risks and provide higher returns.

Who invented electronic trading? ›

E-Trade
Logo since January 1, 2022
TypeSubsidiary
IndustryFinancial services
Founded1982 Palo Alto, California, U.S.
FoundersWilliam A. Porter Bernard A. Newcomb
5 more rows

Which is best strategy for algo trading? ›

Any good strategy for algorithm trading must aim to improve trading revenues and cut costs of trading. The most popular strategies are arbitrage, index fund rebalancing, mean reversion, and market timing. Other strategies are scalping, transaction cost reduction, and pairs trading. `

Is Pi Zerodha free? ›

Zerodha Pi is available free of cost.

Is automated trading legal in India? ›

Yes, algo trading is allowed in India and is legal. India introduced algo trading in 2008 with SEBI opening the doors of algo trading for institutional investors. With the evolution in algo trading, many brokers have extended algo trading to retail investors as well.

How long does it take to learn algorithmic trading? ›

6 month comprehensive course on Algorithmic Trading with certification
Course FeaturesExecutive Programme in Algorithmic Trading (EPAT)
Course duration6 months via weekend lectures
Course modules14 modules
Faculty members15+
Part-timeYes
30 more rows
25 Jul 2018

Why does algo-trading fail? ›

The Biggest Risk: Amplification of Systemic Risk

The speed at which most algorithmic high-frequency trading takes place means one errant or faulty algorithm can rack up millions in losses in a short period.

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