Guide on automated trading: how to create a powerful trading strategy

In recent years, one of the trendiest forms of investment has been automated trading systems, which are built on mathematical algorithms. But, what exactly is automated trading, how does it work, and what are its advantages and disadvantages? In this article, we will provide you with all the answers.

What is automated trading?

Automated trading involves using a computer program to create trades based on predefined criteria. In simple words, automated trading means sending buy and sell orders without any human involvement. Automated trading strategies are specifically made to find market opportunities and execute trades rapidly and accurately.

An automated trading strategy uses predefined criteria (for instance, technical indicators) to generate buy and sell signals, then execute the orders accordingly. As a result, an automated trading strategy can handle various financial assets like stocks, options, futures, currencies, and more, 24 hours a day.

Typically, large institutional investors use automated trading strategies due to their ability to manage numerous trades swiftly and efficiently. However, thanks to many new trading platforms, any investor nowadays can create their own automated trading strategy and trade the markets automatically 24/7.

The undeniable advantage is the time saved compared to manually managing a trading account. Automated systems handle tasks such as identifying the right buy and sell opportunities based on specific variables and sending the orders automatically.

How does automated trading work?

Automated trading relies on a set of predefined rules to generate buy or sell signals in the market. In essence, it's a software system designed to respond to market conditions, making decisions based on predetermined rules and criteria. Moreover, it can execute both buy and sell orders on behalf of the user.

Automated trading is legal in the United Kingdom for retail traders. Automated trading means using a computer program to make trades for you. This is often done through trading platforms that you can connect with software designed to execute trades based on certain rules or strategies.

However, even though automated trading is legal, there are rules and guidelines that must be followed. For example, the software must not be used to manipulate the market or to gain an unfair advantage over other traders.

The rules for small, retail investors are not the same as for institutional investors; for instance, trading firms may employ high-frequency trading, which comes with its own set of rules, risks, and even strategies.

Advantages of automated trading

Automated trading offers several advantages over manual trading:

Absence of emotional biases

Automated trading eliminates human emotions from the decision-making process, preventing irrational decisions based on fear or greed.

Access to a larger number of markets and assets

Automated systems provide access to a wide range of financial instruments and international markets, enabling diverse investment strategies. This may not be possible if you analyse each asset individually and execute each trade manually, as it would be way too time-consuming to be possible.

With automated trading, everything happens within fractions of a second with no intervention on your behalf.

Precise analysis

When you analyse each asset individually, it's impossible to consider more than a few indicators or variables at the same time. The more indicators you add to your trading strategy, the more time-consuming it becomes.

When you use automated trading, you can narrow down your search as finely as you'd like to – and add as many criteria as you need to be successful when trading the markets. Also, when trading manually, there is always the risk of human error, which is entirely eliminated with automated trading.

Disadvantages of automated trading

However, automated trading has its downsides:

Automatic is not synonymous with infallible

In terms of the drawbacks of automated trading, it is necessary to emphasise that although it is an automated system, it does not mean that the system is infallible. In fact, its success will only go as far as the efficiency of your trading strategy. Also, if you had a successful trading strategy in the past, it doesn't mean you will enjoy the same success in the future, too.

Market conditions can change in a split second – however, your automated trading strategy will continue executing trades based on the criteria you set in the past, so you stand to make significant losses. This is why the next aspect is crucial – keep learning and understanding market trends.

Diminishing engagement

It is easy to fall into the trap of neglecting your trading strategy once it's up and running. However, while automated trading saves a lot of time, you still need to do your research, stay up to date with trends, and understand the market conditions that may affect your strategy.

Overall, you need to consistently revise and adjust your automated trading strategy as the market dynamics change.

Backtesting

Finally, automated trading may suffer from over-optimisation due to backtesting, which includes making different assumptions to find the most beneficial scenario for investors.

If you focus extensively on creating a successful strategy using past data, you lose track of what the future may hold. There are many events that could affect your trading strategy. Overall, while backtesting is important, avoid overreliance on past data, otherwise you stand to miss profit opportunities.

Here are some of the main pros and cons of automated trading:

ProsCons
Absence of emotional biasesAutomatic is not synonymous with infallible
Access to a larger number of markets and assetsOverreliance on the automated trading strategy
Detailed analysisOver-optimisation

How to make and implement an automated trading strategy?

There are many trading platforms nowadays that allow you to make and implement an automated trading strategy. However, most of them require advanced coding knowledge.

Fortunately, Interactive Brokers offers Capitalise.ai, a piece of software that allows you to automate your trading strategy using everyday English. Some of the features of Capitalise.ai include:

  • Automate your unique trading strategy with no coding required
  • It monitors real-time market data, indicators, and macroeconomic variables 24/7 so you don't have to
  • Create as many automated strategies as you want to
  • You can backtest and simulate trades with real-time data to test your strategies
  • You gain insights from performance statistics on every trade you make, so you can adjust your strategy in real time

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Summary

In conclusion, if you want to eliminate emotional bias and implement discipline in your trading journey, you may want to learn how to craft and implement an automated trading strategy.

And if you want to try it yourself without the complexity, Interactive Brokers provides a user-friendly tool called Capitalise.ai. With it, you can create and use automated trading strategies using plain language, making the process straightforward and accessible for everyone. This tool can be a great asset in your investment journey.

FAQs

Is automated trading suitable for beginners?

Yes, automated trading can be suitable for beginners. It eliminates emotional biases and allows you to follow predefined rules, making it easier for newcomers to stay disciplined. However, it's essential to choose a reliable platform, such as Interactive Brokers.

Can I customise my automated trading strategy to fit my financial goals?

Yes, you can customise your automated trading strategy to align with your financial goals. Most platforms and tools allow you to define your criteria, risk tolerance, and investment objectives. It's essential to design a strategy that suits your specific needs and monitor it regularly.

What happens if there is a technical issue or a system malfunction during automated trading?

Technical issues can occur, but reputable platforms and brokers have safeguards in place. They often provide customer support to address any problems promptly. Additionally, it's advisable to set up contingency plans and monitor your system's performance to detect any anomalies.

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