Automated trading is based on a computer software program that automatically executes trades on behalf of a trader aligned with parameters established by the individual. Large institutional traders, including hedge funds, rely on automation for much of their trading. Automated trading takes an algorithm that is created based on criteria customized by the user and trades accordingly. It can be applied to multiple asset classes, including stocks, options, futures contracts, and foreign exchange products.
Traders who rely on automation must determine the limits and opportunities that the program should respond to. Parameters include setting entry and exit points, profit targets, technical indicators, price patterns, and more. These conditions serve as instructions to the computer to determine precise points of entry and exit into and out of a market. It works for a trader even when he is not directly watching the markets.
The benefits of automated trading can be far reaching, quite literally; an automated trading program can operate around the clock. This makes it possible for a trader based in the US who wants to trade European securities, which are traded at a five-hour time difference, to walk away from the computer and rest. Automated trades are also executed much more quickly than is humanly possible.
One of the pitfalls of human trading is a tendency to be emotional. When traders allow emotions to interfere with a buy or sell decision, they may exit a trade too soon because of fear or remain in a position for too long due to greed or euphoria. Automated trading removes the threat of trading based on feelings.
Investors do not have to develop their own systems and strategies for automated trading. Vendors sell complete trading systems and signals that a user can incorporate into his or her own program. The most reputable of these vendors do not make unrealistic claims to investors, for instance promising returns of 1,000% in a year. Even after purchasing a trading system, traders must be knowledgeable about the markets to spot potential errors that may occur.
There are some risks associated with automation as well. Computer programs cannot replace human judgment. Traders may want to consider applying automated trading to only the more routine trading tasks rather than relying on the system to perform 100% of buy and sell orders. It may take time to develop and prove a trading system that works, but by practicing and testing trading strategies, investors can increase the chances for success.
