Automated Trading - Friend or Foe to The Retail Algo Trader?
Most people who start trading use a discretionary approach. That is, they make decisions to buy and sell based on things like news, simple chart patterns, and the advice of television talking heads.
Soon after entering a trade, however, the emotions of having real money on the line start to show. The reasons for entering the trade no longer seem as important as the emotions during the trade. Feelings such as hope, fear, greed, stress, and anxiety typically result in bad trading decisions.
Because their emotions get in the way of good trading, many people eschew discretionary trading. They know the disadvantages of trading under duress and therefore look to eliminate all emotions. That leads many people to gravitate towards “emotionless” trading, such as the use of automated programs, algorithmic trading, leasing systems or signals, using a Commodity Trading Advisor, etc.
Unfortunately, completely removing emotions in trading is just not possible. Although it is true that emotions may be manifested in different ways for different types of trading, feelings never go away. This is especially true for automated trading which many people regard as emotionless.
The lure of automated trading is strong – just have a computer decide when to pull the trigger for a trade. The computer never flinches and always does as instructed!
It’s a convenient way to trade but, as hard as it may be to believe, it can still be stressful.
Is The Algorithm Any Good?
First, to trade with an automated algorithm, the trader has to believe in the strategy. Most automated traders neglect this important aspect and their lack of confidence in the strategy leads to all sorts of problems.
First, the trader will have a short leash on the strategy; a few bad trades and the strategy will be turned off and abandoned. Second, most traders will start live trading using an algorithm only after a positive equity run or winning streak. Since winning streaks eventually turn to losing streaks, many traders start live trading at the worst time.
Imagine the fear, anger and stress involved in starting live trading at an equity peak, only to see an immediate drawdown!
How does a trader build confidence in an automated approach? The simplest way is to have a solid strategy development process, one that can consistently and objectively produce money-making strategies. Knowing they have a solid development approach, the trader will find it much easier to let the algorithm just trade.
What About When Something Goes Wrong?
Automated trading can, theoretically, run day or night, and the trader does not have to be glued to the screen. Of course, there are dangers in unattended trading, since things can and do go wrong.
What does a trader do when something goes wrong?
The obvious answer is that he should synchronize the real world and computer strategy positions as soon as possible. But sometimes that is hard to do.
Say, for example, that the algorithm generated a signal to go long, the trade never got entered, and then the price rocketed up? Do you get in immediately, forgoing the lost profit, or do you wait for a pullback?
Many people will wait for a pullback, in a desperate attempt to regain the lost profits. This course of action leads to a lot of anger, greed, and anxiety, until the automation is back on track.
To get around the unexpected “glitch” emotions, the trader needs to have a written plan. With the contingency plan, the trader simply needs to follow what it says, without emotion. If emergencies are properly accounted for, it becomes relatively easy and devoid of emotion.
When Do I Turn It On/Off?
Although having confidence in the strategy and having written instructions to follow when things go wrong can reduce the emotions of automated trading, most people let their emotions take control when it comes to turning the algorithm on or off.
Of course, turning an algorithm off defeats the purpose of having it, yet many traders do just that. Whether it is a feeling about a market, a reaction to a news report, or simply a need to feel “right,” a trader will often sabotage the algorithm by not following it exactly.
When the end result is positive for the trader, he’ll see it as confirmation that applying discretion to the algorithm is a good idea. If the end result is negative, typically the trading strategy, not the trader, will be blamed.
The solution to overcoming this “on/off” mentality is simply to follow the algorithm 100%, without question, and certainly with overruling. The algorithm might still fail eventually, and the trader may have to stop trading it, but that will truly be because of the algorithm’s performance, not the result of a meddling trader.
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Automated trading has become a godsend for many traders. It has many positive benefits, and most traders are well advised to look into automation. But one thing automated trading will not do is eliminate emotions.
The emotions may be different from those experienced with other types of trading, but the bottom line is that whenever money is involved, emotions are present as well. A trader new to automated trading would be well advised to realize this and prepare for it from the start.
About The Author: Kevin Davey is an award winning private futures, forex and commodities trader. He has been trading for over 25 years.Three consecutive years, Kevin achieved over 100% annual returns in a real time, real money, year long trading contest, finishing in first or second place each of those years.
Kevin is the author of the highly acclaimed book "Building Algorithmic Trading Systems: A Trader's Journey From Data Mining to Monte Carlo Simulation to Live Trading" (Wiley 2014). Kevin provides a wealth of trading information at his website: http://www.kjtradingsystems.com
Copyright, Kevin Davey and KJ Trading Systems. All Rights Reserved. Reprint of above article is permitted, as long as the About The Author information is included.
Kevin is the author of the highly acclaimed book "Building Algorithmic Trading Systems: A Trader's Journey From Data Mining to Monte Carlo Simulation to Live Trading" (Wiley 2014). Kevin provides a wealth of trading information at his website: http://www.kjtradingsystems.com
Copyright, Kevin Davey and KJ Trading Systems. All Rights Reserved. Reprint of above article is permitted, as long as the About The Author information is included.