Automated trading is becoming increasingly popular in the retail trading space.
This is largely because of the development of personal computing power, the simplification of computer software trading language, and the recognition that in order to be successful in the markets a mechanical and disciplined approach is essential.
Through education, retail traders are becoming increasingly aware that trading on a discretionary or subjective basis is almost impossible to sustain in the long-term.
There are some people out there who have both the requisite ability and the necessary control over their emotions to be successful discretionary traders, but these people are most definitely the exception to the rule.
Most of us mere mortals get caught up in the emotion of trading, i.e. fear and greed plague our decision making. We may be able to avoid the consequences of these largely uncontrollable emotions for some time but they eventually they catch up with us and destroy our capital and our resolve.
In my early trading days I distinctly remember suffering a string of losses. Seeing my capital erode I foolishly and fearfully decided that I would significantly increase my position size on the next trade in order to try and make my money back in one hit…I’m sure you can guess how the story ends.
The beauty of a mechanical/automated trading system is that it eliminates the subjective elements of trading, which are indeed the ones that will likely get you into the most trouble when in the heat of battle.
Mechanical trading systems can range from basic charts patterns or simple indicator triggers used to enter and exit trades, all the way up to advanced mathematical algorithms which control all aspects of the trade and which are executed automatically through a trading platform.
What form an automated system takes isn’t really all that important. What is important, however, is that it is, in fact, a ’system’; a predefined set of rules and conditions which govern trading behaviour.
By having a well defined system that will tell you exactly how to act in any given situation, and applying that system consistently and constantly, it will ensure that no decision needs to be agonised over. Indeed the more and more automated you can make your trading, the less and less you will ever have to worry or fret over a decision.
This all sounds rosey but how does one go about developing, testing, and applying a trading system?
In regards to the development, this needs to be done prior to trading commencing. That sounds quite obvious but you would be surprised how many novice and even some experienced traders try to develop a system on the fly (i.e. whilst they are already trading).
The thinking about and development of the system needs to be done beforehand and you need to be quite specific as to what your conditions/rules will be, particularly in relation to your entry, trade management, exit, and capital management/position size.
Having laid out your rules and conditions, the system then needs to be backtested. Provided the results are sound, it is then ready to be traded.
Once the system is developed is ready to be traded, it then needs to be strictly applied, i.e. there can be no deviation from the plan/rules.
This is one area that many traders struggle with for a number of reasons.
Firstly, they may attempt to cherry pick trades in order to increase their performance. Cherry picking involves trying to pick the ‘best’ trades and avoiding the ‘bad’ trades. As you may well appreciate, this entirely defeats the purpose of having an automated system by inserting your personal bias back into the process. This is, of course, the very thing you are trying eliminate by automating your trading.
Usually, cherry picking ends in disaster with traders picking the ‘wrong’ trades (ones that lose them money) and missing the ‘right’ ones (those that make them money). As Murphy’s Law states…what can go wrong, will go wrong.
Secondly, the system may be beyond the logistical capabilities of the person trying to implement it. For example, there is no point in someone who works 9-5 and who can’t always access a computer trying to implement an intraday FX system which requires trades to be taken at any hour of the day.
It is not practical and it will not work.
A system needs to be designed with the end user in mind, i.e. the person who is actually going to be placing the trades, so that they are actually capable of sticking to the rules (unless, of course, it is all done by computer, but this is only applicable to experienced traders).
Most people will be looking at an end-of-day data driven system which can see orders placed outside of market hours, after someone comes home from work for example.
Once a system is implemented and trading is under way, the next part of the process involves managing the system.
Inevitably any system, no matter how robust it is, will have negative or ‘drawdown’ periods in which the system may suffer a string of losses. These periods not only reduce a trader’s account but will also challenge the trader emotionally.
In my opinion, the best way to handle a drawdown period is to remain confident, trust the system and, above all else, don’t deviate from the process or adjust your money management rules.
You haven’t spent weeks or months developing a system just to throw it out after the first string of losing trades. If you have tested your system correctly, you will know what is likely and not likely and should be both mentally and emotionally prepared for this scenario.
The only time you might worry is if the results start falling outside of your system’s expectations; for example, your system test might have shown that over a 10-year period the longest number of consecutive losing trades was four in a row. If, suddenly, your system loses eight trades in a row, you would consider reviewing your system.
It should be noted that systems can and do suffer system death from time to time. Good traders will be in tune with both their system and the rhythm of the market to know when changes/refinements to the system are necessary.
Without going into more specific detail about how to build a system and programming language, that’s about all I can tell you about automated trading via this article.
Mechanical, automated systems that are well researched, developed and tested over varying markets conditions will almost always lead to better, more profitable results than discretionary trading.
Over the longer-term, there is no doubt that a mechanical system will ensure that you engage with the market in a consistent and disciplined manner.
This will allow you to minimise the emotional stress and subjective element of your trading, which should, in turn, lead to better results.
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Chris completed a double degree in Law and Economics before deciding his interest lay in financial markets rather than the judicial arena - and who can blame him? Working for an independent stock market research company for the last four years, Chris has developed his skill set as a financial analyst and trader. Through personal study, accredited learning and time in the industry, Chris has a well rounded skill set for analysing many types of financial instruments including stocks, indices, currencies, and commodities.
Chris’ passion lies with technical analysis and he has completed a Diploma in Technical Analysis (ATAA) and has a Certified Financial Technician (IFTA) accreditation.
Chris supports his strong technical skills with a solid understanding of economic relationships and fundamental influences
