What are Automated Trading Systems?
Automated trading systems use algorithmic trading to create buy and sell orders on the stock market or other exchanges. A computer program can be customized to specific trading strategies. It places orders based on these strategies and predetermined guidelines that are programmed within the algorithms.
Automated trading systems can take into account anything from technical analysis to very advanced mathematical and statistical calculations. Once the automated system is completed, investors can take a slightly more hands-off approach, as the computer will complete the majority of the work.
However, the system still needs to be monitored to ensure it is running as it should be. It is often attractive to investors because it takes the emotion out of trading, which can frequently impact trading strategy.
- Automated trading systems utilize computer programs to follow an investment strategy to create buy and sell orders on stock markets and other exchanges.
- The algorithm will make the trades based on predetermined rules from technical indicators or more advanced computations.
- Although automated systems still require oversight, they can much more efficiently create buy and sell orders that directly follow any investing strategy much more precisely than a human can.
How They Work
Automated trading systems use algorithmic trading based on entry and exit rules determined by the investor. The automated systems can use fundamental technical indicators to build out the set of rules. Often, trading platforms will have “wizards” with a variety of technical indicators available for use in trading strategies that the investor can choose from.
Automated trading systems can also utilize much more all-inclusive strategies that require more understanding of the specific platform being used and its programming language. For this more complex strategy, the trader will often work very closely with a programmer to develop the system based on their specific trading strategy.
Building a custom system takes much more time and has higher costs; however, it provides much more flexibility and will often produce a much higher return if done correctly. The algorithm can be backtested on historical market data to see how it would have performed before and provide a more realistic performance outlook to the future.
A few predictions suggest that soon 90% of transactions will take place via automated systems. Even with the high number of trades taking place through automated platforms, there are still downfalls to the system. Artificial intelligence and technology must face some scrutiny to ensure events such as the 2010 Flash Crash do not reoccur.
2010 Flash Crash
A flash crash results from a rapid sell-off inf the stock market, subsequently declining the stock price over just a few minutes. One of the most noteworthy flash crashes happened on May 6, 2010. Automated trading systems exacerbated the crash as they saw the dropping stock price and automatically started selling extreme volumes to try and evade losses.
With the increase in automated trading, a closer look must be taken at flash crashes. Most of the crashes are prompted by computer algorithms rather than actual news from the market or company. As the price drops, more and more indicators are triggered within the algorithm that results in sell orders, which can turn into a domino effect, plunging the stock price.
Advantages of Automated Trading Systems
One of the main advantages of utilizing automated trading systems is the absence of emotion that is used in the trading process. Removing emotions from trading helps the trader not make irrational decisions and stay true to their trading strategy outlined in the algorithm.
Traders also won’t second guess themselves in their trades and delay their buy or sell orders. It enforces discipline at all times, which is especially key in times of volatility. This results from the trading plan precisely being followed, and there won’t be any opportunity to hold a trade a little longer to try and squeeze more profits or sell early to avoid losses.
Automated trading systems also improve the speed at which trades can be made. Computers can respond instantly to indicators that satisfy their algorithm and allow for much faster transactions and more orders to be made in a shorter amount of time and with more precision.
The computer can also follow various strategies at the same time – much easier than a human ever could. This allows the investor controlling the system to pursue a more diverse trading strategy.
Disadvantages of Automated Trading Systems
Using automated trading systems comes with drawbacks as well. Contrary to what many people first think, automated systems are not entirely hands-off. Oversight is still needed to ensure that automation is running correctly and no unexpected failures occur.
Some examples include mechanical failures, such as software malfunctions or connectivity disruption. Additionally, how an algorithm performs with historical market data might be completely different from how it will perform in the future. It can lead to overly optimistic projections and, therefore, large losses or underperformance.
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