Is Bot Trading a Good Idea? A Closer Look
According to CNBC, 85 percent of professional traders underperform their benchmarks over multi-year periods. And with another study showing that only 3 percent of Brazilian day traders were profitable after a year of trading, the numbers are confirming the one thing that all traders can agree on:
Making a living through the stock market isn't easy.
For many current and aspiring traders looking for anything that can give them an edge, bot trading seems like a natural solution. All you have to do is add a few inputs, unleash the model, and let the algorithm print money while you sleep. Or at least that's how the reasoning goes.
But is algorithmic trading really the profit-generating silver bullet that will put you on trading Mount Rushmore? Should you try to bot trade your way to an early retirement?
If you want to get a realistic look at what bot trading strategy could mean for your trading prospects, you've come to the right place. Keep reading to learn more about the ins and outs of bot trading.
Making a living through the stock market isn't easy.
For many current and aspiring traders looking for anything that can give them an edge, bot trading seems like a natural solution. All you have to do is add a few inputs, unleash the model, and let the algorithm print money while you sleep. Or at least that's how the reasoning goes.
But is algorithmic trading really the profit-generating silver bullet that will put you on trading Mount Rushmore? Should you try to bot trade your way to an early retirement?
If you want to get a realistic look at what bot trading strategy could mean for your trading prospects, you've come to the right place. Keep reading to learn more about the ins and outs of bot trading.
What are the Benefits of Algorithmic Trading?
In 2021, an estimated 60 to 73 percent of all equity trades were executed by algorithms. Why has Wall Street started executing most of its trades this way? Here are just a few of the reasons why bot trading is becoming the weapon of choice for stock market traders:
1. Speed
According to Guinness World Records, the fastest punch time ever achieved was 0.186 seconds. In an equity market where prices move quickly and trade execution delays can cost thousands or millions, you would almost have to be a comic book character to jump in and out with 100-percent accuracy.
One of the biggest advantages of algorithmic trading is that your bot can find and enter trades with more speed than you can. Your bot can be trained to monitor multiple markets at once with an ease that most people would struggle to match even with three high-definition monitors and a phone running for good measure.
For many traders, the convenience of not having to pull the trigger manually while watching multiple markets is enough to make algorithmic trading worth its weight in gold.
2. You Can Have End-to-End Control
With the bot finding, executing, and exiting your trades, it's easy to assume that the system is in the driver's seat once you've added it to your trading platform. However, nothing could be further from the truth.
Here's why:
You don't just test, optimize, and accept the results with an algorithmic trading system — you can backtest, choose the exact parameters, and continuously make changes as new information comes. And if market conditions change or you're dealing with more price volatility than expected, you can create additional algorithms for that as well.
This level of control makes it easy for you to keep iterating and perfecting your trading systems.
3. It's a Common Form of Trading
Normally the phrase, "Everybody's doing it." isn't exactly stellar trading advice. But in this case, the fact that automated trading systems are common is a good thing.
Think back to the first time that you used Excel or adopted a new piece of software at your workplace. Chances are that there were bugs, hiccups, and road bumps that prevented you from utilizing the tech as intended right away.
Fortunately, that's not the case with trading algorithms.
Because you can build systems through Tradestation, you don't have to worry about whether or not you'll be able to find a broker that can integrate your bot. And secondly, because everyone, from Wall Street brokers to part-time traders, is actively making use of automated trading systems, you won't find yourself dealing with tech-related performance issues.
When you backtest your trading system, you want to be innovative and creative when it comes to your parameters. But you need your trading platforms of choice to be technologically compatible with your algorithm. The fact that bots are expected to be the way of the future on Wall Street is a good thing for your trading prospects.
According to Guinness World Records, the fastest punch time ever achieved was 0.186 seconds. In an equity market where prices move quickly and trade execution delays can cost thousands or millions, you would almost have to be a comic book character to jump in and out with 100-percent accuracy.
One of the biggest advantages of algorithmic trading is that your bot can find and enter trades with more speed than you can. Your bot can be trained to monitor multiple markets at once with an ease that most people would struggle to match even with three high-definition monitors and a phone running for good measure.
For many traders, the convenience of not having to pull the trigger manually while watching multiple markets is enough to make algorithmic trading worth its weight in gold.
2. You Can Have End-to-End Control
With the bot finding, executing, and exiting your trades, it's easy to assume that the system is in the driver's seat once you've added it to your trading platform. However, nothing could be further from the truth.
Here's why:
You don't just test, optimize, and accept the results with an algorithmic trading system — you can backtest, choose the exact parameters, and continuously make changes as new information comes. And if market conditions change or you're dealing with more price volatility than expected, you can create additional algorithms for that as well.
This level of control makes it easy for you to keep iterating and perfecting your trading systems.
3. It's a Common Form of Trading
Normally the phrase, "Everybody's doing it." isn't exactly stellar trading advice. But in this case, the fact that automated trading systems are common is a good thing.
Think back to the first time that you used Excel or adopted a new piece of software at your workplace. Chances are that there were bugs, hiccups, and road bumps that prevented you from utilizing the tech as intended right away.
Fortunately, that's not the case with trading algorithms.
Because you can build systems through Tradestation, you don't have to worry about whether or not you'll be able to find a broker that can integrate your bot. And secondly, because everyone, from Wall Street brokers to part-time traders, is actively making use of automated trading systems, you won't find yourself dealing with tech-related performance issues.
When you backtest your trading system, you want to be innovative and creative when it comes to your parameters. But you need your trading platforms of choice to be technologically compatible with your algorithm. The fact that bots are expected to be the way of the future on Wall Street is a good thing for your trading prospects.
Are There Any Downsides to Bot Trading?
When all is said and done, speed, convenience, and tech integration are all extremely good reasons to make algorithms a part of your trading strategy. But even with all of these positives, there are some risks associated with bot trades that traders need to be aware of:
1. Your Model Could Be Overfitted
According to IBM, overfitting is what happens when you've got a model that's designed to fit perfectly against its training data.
You might look at a trading system with a 99.9 percent accuracy rate in the backtest and think, "I don't see a problem here.". But the truth is that an overfitted model is likely to grossly underperform in real market conditions. And to make matters even more frightening you might not even realize that there's a problem until it's too late.
Here's why:
A trading system that is perfectly attuned to its training data will have a difficult time performing to the same standard against data it hasn't seen before. If you're planning to build your own system, you'll have to find a way of testing it against real-time market conditions if you want to maintain accurate performance conditions.
2. The Losses Can Be Huge
In 2012, BBC reported on an automated trading disaster that ended with $440 million in total losses. The reason for this disastrous foray into the NYSE? There was a mistake in the computer program that the company was using.
For many traders who rely on bots to enter and exit positions, a bug in their trading platform is unlikely to be the cause of major losses. But even so, there's an element of risk involved with bot trading that can't be overlooked.
You could have a weak internet connection. Your neighborhood could be subjected to a power outage. There could even be a problem on your platform's end that results in missed orders.
When you're trading manually, you can see what's happening and adjust your actions accordingly. However, when the bot is in charge, you could end up with mistimed positions or duplicate orders through no fault of your own. If you're involved in leveraged trading and you're not in a position to handle a sudden margin call, one small problem with the algorithm can snowball into something serious.
3. You Can’t Take Emotion Out of the Equation
At first glance, this drawback might seem a bit counterintuitive. After all, the bot isn't going to sit around overthinking positions and agonizing over potential trades.
But even if the algorithm can enter positions without thinking twice about it, the simple reality is that stock market traders are always hoping for winning trades. And just because the bot is doing the trading, that doesn't mean that you're not emotionally invested in watching your account grow.
When you've underestimated a market correction or you're otherwise in a losing trade, you can quickly find yourself having a lumber futures moment. Unfortunately, bot trading isn't going to protect you from the fallout of losing money or seeing a temporary drop in your trading account gains.
1. Your Model Could Be Overfitted
According to IBM, overfitting is what happens when you've got a model that's designed to fit perfectly against its training data.
You might look at a trading system with a 99.9 percent accuracy rate in the backtest and think, "I don't see a problem here.". But the truth is that an overfitted model is likely to grossly underperform in real market conditions. And to make matters even more frightening you might not even realize that there's a problem until it's too late.
Here's why:
A trading system that is perfectly attuned to its training data will have a difficult time performing to the same standard against data it hasn't seen before. If you're planning to build your own system, you'll have to find a way of testing it against real-time market conditions if you want to maintain accurate performance conditions.
2. The Losses Can Be Huge
In 2012, BBC reported on an automated trading disaster that ended with $440 million in total losses. The reason for this disastrous foray into the NYSE? There was a mistake in the computer program that the company was using.
For many traders who rely on bots to enter and exit positions, a bug in their trading platform is unlikely to be the cause of major losses. But even so, there's an element of risk involved with bot trading that can't be overlooked.
You could have a weak internet connection. Your neighborhood could be subjected to a power outage. There could even be a problem on your platform's end that results in missed orders.
When you're trading manually, you can see what's happening and adjust your actions accordingly. However, when the bot is in charge, you could end up with mistimed positions or duplicate orders through no fault of your own. If you're involved in leveraged trading and you're not in a position to handle a sudden margin call, one small problem with the algorithm can snowball into something serious.
3. You Can’t Take Emotion Out of the Equation
At first glance, this drawback might seem a bit counterintuitive. After all, the bot isn't going to sit around overthinking positions and agonizing over potential trades.
But even if the algorithm can enter positions without thinking twice about it, the simple reality is that stock market traders are always hoping for winning trades. And just because the bot is doing the trading, that doesn't mean that you're not emotionally invested in watching your account grow.
When you've underestimated a market correction or you're otherwise in a losing trade, you can quickly find yourself having a lumber futures moment. Unfortunately, bot trading isn't going to protect you from the fallout of losing money or seeing a temporary drop in your trading account gains.
Bot Trading Best Practices
Let's assume that you've taken a look at the risks and you're still 100 percent convinced that an algorithmic trading style is your best shot at success. Whether you're a seasoned stock market trader or a freshly minted trader, there are some key pieces of advice that you can use to give yourself a better shot of success.
Here are three key pieces of advice that every bot trader should keep in mind:
1. It's Not a Get Rich Quick Scheme
In another article, we calculated the time it would take to turn a small account into a solid five-figure income. And this is what we found:
If a trader were to start with a $10,000 account, they'd likely need to trade for another 26 years before an annual $50,000 withdrawal would even be possible.
A lot of people see the insane returns and the seven-figure windfalls generated by the major players and think that the stock market is going to be their ticket to becoming rich. And because algorithmic traders have a solid shot at beating the market on a year-to-year basis, it can be tempting to bring that mentality to your trading.
It doesn't matter if you're a swing trader, a day trader, or a futures trader — it's important to realize that your best shot at generating an income is to be patient. Not everyone can score home runs every time they step to the plate. But if you can be content with hitting singles and moving to the next base as you go, you'll have a much better chance at grinding out enough wins to have a shot at the World Series.
2. Have a Robust Testing Process
There's having a trading system strategy. And then there's having a proven set of trading system results.
Many traders have ideas that sound good on paper:
"I'll just create a system that wins at least 90 percent of the time!"
"All I need to do is find a formula that will win no matter what!"
But if your trading system can't hack it in real market conditions, all of those theories amount to nothing. So how do you create an algorithmic trading system that's profitable? You have a rigorous testing process that takes the information you need into account.
Going back to the previous examples, the problem with pinning your hopes on winning 90 percent of the time is the reality that winning percentages don't guarantee profits. You could win 98 percent of your trades, but if every trade makes you $1 while every loss costs you $10,000, you'll have a hard time breaking even — never mind being profitable.
You don't necessarily need a ton of complicated rules and metrics to create algorithmic trading systems that work. But regardless of the metrics and parameters you choose to set, you'll want to make sure that your backtesting process is effective enough to let you separate the winning algorithms from the unprofitable ones. And then, when the system is up and running, you'll need to make continuous monitoring a part of your daily routine.
3. Don't Be Afraid to Cut Your Losses
Imagine that you've got an algorithmic trading system that seemed like a legitimate moneymaker during tests. You did everything right in terms of the creation and data management process. And on paper, you should be making bank.
However, it seems like no matter what market you point your model at, it feels like you're losing a lot of money at every turn. And even when the trade works out, you're not comfortable with the journey that the algorithm is taking to get there.
In the same way that traders will often fall in love with companies that just aren't generating enough returns, it's easy for bot traders to get attached to the algorithms they've created. But if you're unhappy with the results you're getting and the algorithm isn't matching your standards, it's okay to call it quits.
As we've said before, the important thing is that you have an objective set of quitting rules that you stick to.
Here are three key pieces of advice that every bot trader should keep in mind:
1. It's Not a Get Rich Quick Scheme
In another article, we calculated the time it would take to turn a small account into a solid five-figure income. And this is what we found:
If a trader were to start with a $10,000 account, they'd likely need to trade for another 26 years before an annual $50,000 withdrawal would even be possible.
A lot of people see the insane returns and the seven-figure windfalls generated by the major players and think that the stock market is going to be their ticket to becoming rich. And because algorithmic traders have a solid shot at beating the market on a year-to-year basis, it can be tempting to bring that mentality to your trading.
It doesn't matter if you're a swing trader, a day trader, or a futures trader — it's important to realize that your best shot at generating an income is to be patient. Not everyone can score home runs every time they step to the plate. But if you can be content with hitting singles and moving to the next base as you go, you'll have a much better chance at grinding out enough wins to have a shot at the World Series.
2. Have a Robust Testing Process
There's having a trading system strategy. And then there's having a proven set of trading system results.
Many traders have ideas that sound good on paper:
"I'll just create a system that wins at least 90 percent of the time!"
"All I need to do is find a formula that will win no matter what!"
But if your trading system can't hack it in real market conditions, all of those theories amount to nothing. So how do you create an algorithmic trading system that's profitable? You have a rigorous testing process that takes the information you need into account.
Going back to the previous examples, the problem with pinning your hopes on winning 90 percent of the time is the reality that winning percentages don't guarantee profits. You could win 98 percent of your trades, but if every trade makes you $1 while every loss costs you $10,000, you'll have a hard time breaking even — never mind being profitable.
You don't necessarily need a ton of complicated rules and metrics to create algorithmic trading systems that work. But regardless of the metrics and parameters you choose to set, you'll want to make sure that your backtesting process is effective enough to let you separate the winning algorithms from the unprofitable ones. And then, when the system is up and running, you'll need to make continuous monitoring a part of your daily routine.
3. Don't Be Afraid to Cut Your Losses
Imagine that you've got an algorithmic trading system that seemed like a legitimate moneymaker during tests. You did everything right in terms of the creation and data management process. And on paper, you should be making bank.
However, it seems like no matter what market you point your model at, it feels like you're losing a lot of money at every turn. And even when the trade works out, you're not comfortable with the journey that the algorithm is taking to get there.
In the same way that traders will often fall in love with companies that just aren't generating enough returns, it's easy for bot traders to get attached to the algorithms they've created. But if you're unhappy with the results you're getting and the algorithm isn't matching your standards, it's okay to call it quits.
As we've said before, the important thing is that you have an objective set of quitting rules that you stick to.
Could Algorithms Be the Missing Piece of Your Trading Strategy Puzzle?
If you're the type of trader who loves the idea of generating profits across multiple markets, bot trading is an exciting option. However, if you're expecting to let the bot generate money while you eat, sleep, and compose your resignation letter, you may be disappointed with the results.
Algorithmic trading comes with its own set of pros and cons. You have to teach the bot how to identify the best trade and you have to closely monitor its performance. But once you get the hang of it, algorithms can be a powerful means of generating stock market returns.
See the rest of the site for more in-depth articles on algorithm trading, trading systems, and the day-to-day aspects of trading with automated systems.
Algorithmic trading comes with its own set of pros and cons. You have to teach the bot how to identify the best trade and you have to closely monitor its performance. But once you get the hang of it, algorithms can be a powerful means of generating stock market returns.
See the rest of the site for more in-depth articles on algorithm trading, trading systems, and the day-to-day aspects of trading with automated systems.
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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 5 highly acclaimed books, including "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: https://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 5 highly acclaimed books, including "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: https://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.