What are the Pros and Cons of Automated Trading?

Last Updated: 12 Feb 2024

Trading requires a lot of effort traders need to address numerous factors in the quest to make profits. Some traders believe in making quality orders over quantity, while some prefer to execute many orders quickly. The latter type of trader uses a stock market trading technique known as Automated Trading.

It allows for stock market order execution at an immensely high rate, to earn better profits through higher volume. If you are intrigued, this blog will help you to understand the pros and cons of automated trading. Once you have, you can decide which trading technique to use between manual and automated trading.

What is Automated Trading?

Automated Trading, also known as algorithm trading or mechanical trading system, uses automated trading software backed by algorithms to execute trading orders at high speed. Investors and traders use trading software and feed it pre-programmed trading instructions based on time, volume, and price.

Once the set instructions are triggered in the market, the trading software executes the orders set by the investor. Generally, automated trading is used by Mutual Funds, Hedge Funds, Insurance Companies, Banks, etc., to execute a large number of high-volume trades that are otherwise impossible for humans to undertake.

Automated trading aims to allow investors and traders to increase their profit margin by executing hundreds of trades at once. As humans are limited to executing a handful of trades at once, automated trading eliminates the interference of humans and utilizes algorithms to trade at an unprecedented speed. However, automated trading comes with a complicated structure where investors or traders have to gain knowledge about coding and mathematical models before they can handle automated trading platforms.

How does automated trading work?

Automated trading is fully based on systems that utilize various high-tech and data-based algorithms to execute trading orders. Once investors choose which automated trading system to use as per their investment perspective, they set precise entry, exit, and investment rules into the automated trading system. The rules can be set based on various market conditions such as stop-loss, specific price, moving average crossover, 52-week high or low, etc. However, some professional automated traders set the rules through complicated strategies that may stretch to external factors or their investments in other asset classes.

Once the traders set the rules, they leave the rest to the automated trading system. When running, the automated trading system executes market orders at an immensely high rate as soon as the set rules are accomplished in the market. Furthermore, trading through automated trading systems allows investors to take out human emotions which may negatively influence the profit margin. Since the orders are automatically placed based on the analysis of data and predefined rules, the chances of the order turning out successful increases by a hefty margin.

The pros and cons of Automated Trading

Every stock market strategy, system, or model comes with numerous advantages over other trading strategies. However, it also includes some disadvantages. The same is the case with automated trading. Here are the pros and cons of automated trading to better analyze this trading strategy:

Pros of Automated Trading:

• High Rate of Order Execution: Automated trading allows traders to execute a large volume of orders efficiently. Using automated trading, they can trade multiple accounts and use various trading strategies at once. This ensures that the traders diversify by spreading their risk across numerous investment instruments. The number of trades that would need days to be executed by a human can be done in milliseconds through automated trading.
• Avoids Human Emotions: Professional and experienced investors advocate avoiding human emotions when trading. They feel that human emotions are one of the biggest factors that lead to losses. However, automated trading ensures that human emotions are kept in check and there is no human interference in executing market orders. Thus, the overall profit margin increases for the traders.
• Backtesting: One of the best features of automated trading is its ability to apply trading rules to historical market data to determine the viability of the trading strategy. Hence, when investors choose a strategy for automated trading, the system tests it religiously before the rules are executed, reducing the possibility of unsuccessful execution to a minimum.
• Diversification: Automated trading allows traders to use multiple strategies and accounts at once that spread the risk across asset classes and investment instruments. This allows investors to reduce the possible risks and improve profit margin.

Cons of Automated Trading

• Technical Failures: Automated trading is as good as the automated system used to execute orders. However, as the automated systems are technologically backed, they can malfunction or experience technical failures. If this happens, traders can realize huge losses as the outcome could be negative because of incomplete execution.
• Monitoring: Although the execution is automatic, it still requires some amount of monitoring. This is because the system can experience a host of technicalities like system failure, loss of connectivity, power cut, etc. As these factors can result in errant, missing, or incomplete orders, traders have to monitor the execution.
• Over-optimization: Automated trading requires traders to choose, adjust and manage the trading strategy they use. However, strategies developed by traders using backtesting can look good on paper but may fail in the live market at the time of execution.
• Requires technical knowledge: Automated trading requires traders to have technical knowledge about coding, programming, and software management. As the process of creating automated systems is complex, the trading, when done with ineffective systems can force traders to incur huge losses.

Establishing Trading Rules

Knowing the pros and cons of automated trading is not the end of understanding the automated trading process. For a trader to successfully execute automated trading, there are two trading rules to be followed:

• Using the strategy building ‘wizards’ to identify and select technical indicators from an extensive list to build a set of rules for the automated system. Traders can use various factors such as moving averages, specific prices, etc., to set a predefined action once the factors are accomplished.
• Using custom strategies and indicators to choose a program for the automated system. Here, traders have to put in more effort and ensure their strategies are technically sound before executing the system. Using custom indicators and strategies allow traders better flexibility and may result in higher profits.

Avoid the scams

The pros and cons of automated trading are justified at their levels, however, given its use has increased hugely in the last few years, fraudsters are targeting automated traders. You can avoid these scams by following these steps:

• Inspect before you pay for a trading account and ask some basic questions.
• Do prior research and ensure you have deep knowledge about the system you are buying along with reading the terms and conditions.
• Check online and read reviews about the vendor in question before paying.
• Ensure that the system comes with a trial period as most scam sites do not offer one to the traders.

Final Word

Automated trading is being used by investors who do not want to manually execute stock market orders but want to rely on data-backed algorithms to execute orders on their behalf. They set predefined rules and feed them to the strategy to ensure the orders are automatically executed at a higher pace than manually possible. Avoiding the possibility of human emotions and errors whipping out profits, automated trading allows traders to improve their profit margin. However, as automated trading is an artificial system, technical flaws are common. Hence, it is advised that the traders create or use the system cautiously while constantly monitoring the execution process.

Frequently Asked Questions

Does automated trading work?

Yes, automated trading works successfully for a host of traders. However, the trading system is as good as the strategy followed. Hence, you must ensure that the strategy is well tested before executing orders in the live market.

How do you automate a trading strategy?

For automating a trading strategy, you have to use an automated trading system. It is software that allows traders to set some predefined rules which the system follows to execute orders automatically.

Which trading software is best?

Here are some of the best-automated trading software you can use:

• Best for Variety: Pionex.
• Best for Stock Trading: Interactive Brokers.
• Best for Premium Access: Zen Trading Strategies.
• Best for Preset Strategies: Coinrule.
• Best for Desktop Trading: TradeZero.

What programs do traders use?

There is no specific program used by traders as almost every program is customised based on the investment horizon, and the outcome traders want from automated trading. Hence, it is wise to analyse your goals before choosing a program.