What is an Automated Trading System?

Automated trading systems—commonly referred to as mechanical trading systems, algorithmic trading, or automated trading—facilitate the establishment of specific rules for trade entries and exits. Once these rules have been programmed, the system can execute trades automatically through a computer. As of 2024, it is estimated that between 70% and 80% of shares traded on U.S. stock exchanges are attributed to automated trading systems.

Traders and investors can convert precise entry, exit, and risk management criteria into automated trading systems, which enables computers to execute and oversee transactions. A principal advantage of strategy automation is its capacity to mitigate emotional influences on trading decisions, as trades are executed automatically upon the fulfilment of predetermined conditions.

The criteria for trade entries and exits may be grounded in straightforward parameters, such as moving average crossovers, or they may involve intricate strategies that necessitate a comprehensive understanding of the relevant programming language associated with the specific trading platform. Additionally, these systems can be developed with the assistance of a qualified programmer.

Automated trading systems generally require the use of software connected to a direct access broker. It is essential that all rules are articulated in the proprietary language of the corresponding platform. For instance, the TradeStation platform employs EasyLanguage, while NinjaTrader utilizes NinjaScript. An illustration of an automated strategy that successfully executed three trades during a single trading session is provided below.

There are several advantages to employing a computer system for monitoring market conditions and executing trades automatically. These benefits include:

Minimizing Emotional Bias

Automated trading systems serve to reduce emotional bias throughout the trading process. By mitigating emotional influences, traders are better positioned to adhere to their established trading plans. Once the predetermined criteria for trade execution are met, orders are executed automatically, which eliminates hesitation or second-guessing on the part of the trader. This feature is particularly advantageous for individuals who may struggle with decision-making or for those prone to overtrading by responding impulsively to perceived opportunities.

Backtesting Methodology

Backtesting involves the application of trading rules to historical market data with the objective of evaluating the viability of a trading strategy. It is crucial that, when designing an automated trading system, the rules are specified clearly and without ambiguity; computers cannot interpret or make subjective judgments. Traders can utilize these explicit rules to conduct backtests on historical data prior to committing capital to real-time trading. Thorough backtesting allows for the analysis and refinement of trading strategies while determining the system’s expectancy, which refers to the average expected gain or loss per unit of risk.

Maintaining Discipline

Discipline is preserved through automated trading systems, which execute established trade rules without deviation, even in volatile market conditions. Emotional factors such as fear of loss or excessive greed can compromise a trader’s discipline. Through strict adherence to the trading plan, automated trading minimizes instances of human error. For example, an order to purchase 100 shares is less likely to be erroneously entered as an order to sell 1,000 shares.

One of the significant challenges in trading is the necessity to effectively plan trades and execute those plans consistently. Even a potentially profitable trading plan can yield unfavorable results if the rules are disregarded. It must be acknowledged that no trading system guarantees success 100% of the time, as losses are an inherent aspect of financial trading. Nevertheless, a series of consecutive losses can adversely affect a trader’s confidence, potentially leading them to skip subsequent trades. If a subsequent trade is profitable, the trader undermines the expectancy of their system. Automated trading systems facilitate the maintenance of consistency by ensuring strict compliance with predefined plans.

Enhancing Order Entry Speed

Automated trading systems are capable of responding immediately to fluctuations in market conditions, thereby generating orders as soon as the specified trading criteria are satisfied. An expedited entry or exit, even by a few seconds, can significantly influence the outcome of a trade. Once a position is established, all related orders, such as protective stop-losses and profit targets, are automatically generated. In rapidly changing markets, it can be discouraging when a trade fulfills the profit target or surpasses the stop-loss level before the relevant orders are executed. Automated trading systems effectively mitigate these issues.

Facilitating Trading Diversification

Automated trading systems allow users to manage multiple accounts or diverse trading strategies concurrently. This capability can effectively distribute risk across various financial instruments while serving as a hedge against potential losses. Tasks that would prove extraordinarily challenging for a human trader to execute can be efficiently performed by a computer in mere milliseconds. The system can continuously scan for trading opportunities across a wide array of markets, generate orders, and monitor ongoing trades effectively.

The Bottom Line

Automated trading systems, while attractive for various reasons, should not be viewed as substitutes for meticulously executed trading strategies. Technology failures are a possibility, necessitating the need for ongoing monitoring of these systems. For traders seeking to mitigate the risks associated with mechanical failures, server-based platforms may offer a viable solution. It is imperative that individuals possess a substantive level of trading experience and knowledge before opting to utilize automated trading systems.

Source: www.investopedia.com