Automated trading systems have many advantages and benefits. For one, they remove the emotions out of trading, which means you can stick more easily with your trading plan. It therefore also improves trading discipline. At the same time, you can backtest your trading strategy using historical market data.
On the flipside, though, automated trading systems also sport downsides that may not be suitable for some kinds of traders. In this article, we explore these downsides to help you decide whether an automated trading strategy is for you or not.
Ideally, automated trading systems work as the name suggests: automatically. It’s also pretty straightforward: set the rules, and let the computer run the trade.
However, in the real world, program failures and mechanical glitches happen. Yes, automated trading is a sophisticated trading strategy. But it is not perfect.
For instance, if the internet connection is suddenly lost, an order may not be sent to the market. There could also be some errors between trades from the strategy.
Traders should expect some kind of learning curve with automated trading systems. The trick is to start small—use small trade sizes—while the automated process is still being polished.
Problems with Monitoring
Even though turning on the computer and leaving for the day sounds thrilling (not really), automated trading systems still require some amount of monitoring.
Keep in mind that chances of technical failures, connectivity problems, power interruptions, and computer and system crashes still exist.
That means the automated trading system could still experience anomalies, which could reap errant orders, missing orders, or duplicate orders.
To resolves these issues, you still have to be alert and monitor the system often.
Although this issue is not exclusive to automated trading systems, traders who use backtesting techniques can design systems that appear to be great but perform horribly badly in a live market.
Overoptimization is a thing; it refers to the excessive curve-fitting that results in a trading plan or system which traders cannot rely upon.
For example, it’s possible to design a strategy that could achieve exceptional results on the historical market data on which is was backtested.
Traders then incorrectly assume that a trading plan could have near 100% efficiency and profitability (never experiencing a drawdown).
They then tweak the parameters to create an almost perfect trading plan, which succumbs to failure once applied to a real-world, real-time situation.
Traders search for trading systems which they will use on their trade. But sometimes, it’s too good to be true. And remember that if it’s too good to be true, it probably is not true.
Some systems sold by suspicious or disreputable brokers or sellers promise high profits for low prices. Keep in mind that scams exist and the market has a lot of those going around.
To determine whether the system is legitimate or not, scrutinize anything that you have to pay for before laying down any money. Always ask a lot of questions.
Check the testimonials if any and do your research. Be sure to read the terms and conditions before you commit.