Automated trading is an approach that is faster owing to the usage of the automated system for executing trade orders. With your expertise in the trading domain, you can automate your trading approach instead of manually carrying the trade execution. In this blog, you will learn all about knowing and getting started with an automated trading approach.
The blog covers:
- What is automated trading?
- History of automated trading
- Working of automated trading
- Difference between automated trading and algorithmic trading
- Difference between old and new brokerage model
- Example of automated trading and algorithmic trading
- Prerequisites for practising automated trading
- Resources to learn automated trading
- Steps to building an automated trading system
- Benefits of automated trading
- Drawbacks of automated trading
What is automated trading?
Automated trading uses computers to generate trading signals, send orders and manage portfolios using algorithms with or without human intervention. Sophisticated electronic markets/platforms are used by the algorithms to trade in a similar fashion as done in electronic trading.
History of automated trading
Speaking about how automated trading began and went on to become so useful for traders, let us see one by one the journey of “automated trading” from the beginning:
- It was in the year 1949 when Richard Donchain first introduced the concept of an automated trading system. He made use of a set of rules for buying and selling the financial markets’ assets.
- Then, it was in the 1980s that rule-based trading became popular amongst traders as famous traders such as John Henry and the likes started using rule-based trading strategies.
- It was in the mid-1990s that the improvised versions of automated stock trading models became available for purchasing. These trading models also raised the accessibility for retail investors in the financial markets’ trading domain. However, in today’s time, the automated trading system is taking care of assets across the globe.
Working of automated trading
Automated trading works in a simple and systematic manner that is completely based on the commands/instructions/parameters set by the trader. Let us see how the automated trading system works stepwise:
- For the automated trading system to work, first of all, the trader will need a platform where you will set the parameters of your trading strategy.
- Then, on the basis of trading experience, the trader will create entry/exit positions which will be done via an instructed input.
- These rules and conditions will be based on the time of the trade, the price at which the entry and exit positions will take place and the quantity of trade.
- These algorithms will place the trade on the behalf of the trader every time the conditions are met.
- For instance, the automated stock trading system can be instructed with the help of algorithms to buy 200 Apple shares when its 100-day moving average goes above the 250 day average.
- The automated trading system will constantly keep monitoring the financial market prices, trades etc. and will execute the trade whenever the predetermined instructions/parameters are met.
The following diagram explains the entire process of an automated trading system:
Difference between automated and algorithmic trading
Let us find out how automated trading and algorithmic trading are different from each other with this table:
|
Automated Trading |
Algorithmic trading |
|
The instructions can not be in detail. For instance, you can automate the trade execution once and not put conditions unlike trading with algorithms |
The computer program is used to follow a defined set of instructions or rules to calculate the price, quantity, timing and other characteristics of the orders. In other words, trading signals (buy/sell decisions) are generated based on a set of instructions. |
|
The universe for trade execution is limited to one of the financial markets, say stock market and in one of the products, say futures |
Algorithmic trading efficiently increases the universe being traded by an individual trader. For instance, the algorithms can be coded to execute trades in more than one financial market such as in stock, commodities, crypto etc. and for a variety of products such as futures, options etc. |
|
Constant human intervention is needed every time whenever a new condition is needed to be set |
Very less human intervention is needed since the algorithms are coded with all conditions at once |
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Example of automated trading and algorithmic trading
In automated trading, the orders are executed electronically according to the set parameters and instructions as we saw in the image above. For instance, automated trading does not work with the detailed instructions regarding price, volume etc. of your preference. The automated trading system can be instructed to enter the trade at 2 pm and exit at 3 pm. That’s it!
Whereas, in the case of algorithmic trading, you can create a set of rules and conditions via algorithms. For instance, you can create the algorithm to enter the trade in case the price goes below 50$ or else exit the trade. Therefore, the decisions can be taken by keeping into account the details regarding price, size of the position etc.
Before we delve into the prerequisites and steps for building automated trading strategies, take a moment to watch this captivating video as we explore the essential setup process.
Prerequisites for practising automated trading
You can find the steps for learning algorithmic trading and learn this contemporary process step by step. There are not so many prerequisites for learning automated trading since learning might be difficult but is doable. But, before you begin practising automated trading, these are the prerequisites:
- Knowledge of markets
- Strategy creation
- Coding experience
Knowledge of markets
Having a good knowledge of markets or being a manual trader already helps in becoming an automated trader. The manual trading experience helps because automated trading requires the trader to automate the trade order execution on the basis of understanding of the market.
For instance, if you have manual trading experience, you will be able to analyse whether buying a particular stock at a particular price will lead to desired returns or not. After making the decision, you will be able to automate the system accordingly.
Learning the stock markets will be much easier for you if you are able to grasp the basics. This free course on the basics of the stock market is designed to help you with the core concepts.
Strategy creation
The other prerequisite for beginning the practice of automated trading is knowing the strategy creation process well. All the trades must be executed with the right strategy (based on the situation of the market and performance of the stock, commodity etc.) for the best outcome.
There are several quantitative trading strategies and models that you can learn to be able to use the most effective strategies for your portfolio.
Coding experience
A good coding experience is a must for automated trading since, then, you get the option to automate all the strategies via algorithms. Python programming is considered to be the most popular programming language in today’s time.
By learning the basics of Python programming, further, you can practise coding for your trading journey. Moreover, practising well can help you become better at programming your automated trading strategies.
Resources to learn automated trading
With our blog on Free Resources to Learn Algorithmic Trading - A Compiled List find out the exclusive resources that you can get your hands on free of cost!
Whereas, for learning through paid resources, you must visit our blog on What is Algorithmic Trading. Under the subtopic “How to learn algorithmic trading” in the blog, you will be able to find some useful courses and books (paid).
Steps to building an automated trading system
Building your own automated trading system does require proper planning and execution with regard to hardware, software, knowledge of automation etc. With our interesting and comprehensive blog on Setting-Up An Algo Trading Desk, you will find all the necessary steps for building an automated trading system and get started!
Now that you have successfully built an automated trading system here is a tutorial to help you through the process of downloading historical stock data using Python. If you are interested in automated trading and want to analyze historical stock data for developing your trading strategies, this video is perfect for you.
Benefits of automated trading
Automated trading is an approach that is faster and more efficient than manual trading. Let us see the benefits in detail, which are:
Backtesting
Allows backtesting which is an important inclusion for a successful trading strategy with favourable results. When you backtest, you find out if the strategy is favourable on historical data or not. With the help of the results on past data, the strategy you have built is validated for current data. Hence, better outcomes.
Emotions
Lesser emotions play a big role while trading. Emotions such as fear, greed etc. drive your trading decisions in a manual approach to trading. Whereas, in the case of automated trading, emotions are kept at bay since the computerised system takes care of trading according to the set preferences by you.
Approach
More disciplined approach is seen in automated trading since in manual trading, it is not always possible for humans to follow a disciplined pattern due to situations such as volatility in markets.
During volatility it is possible for the manual traders to make decisions based on incorrect expectations of market falling or rising in future. But, with a trading plan or trading instruction given to the automated system, one can maintain a disciplined approach.
This disciplined approach will allow you to execute trades with backtesting and a proper trading strategy.
Time
Moreover, automated trading saves a lot of time for the trader by monitoring the market quickly (more quickly than is possible for any human being). This helps in finding out the best opportunities without wasting much time.
Drawbacks of automated trading
All the drawbacks of automated trading go as follows:
Fixing
A mechanical system, sometimes, is bound to get stuck, unlike humans. In case the system is stuck, the same needs to be fixed. For instance, a mechanical system may slow down a bit leading to delays in actions (not entering the market at 2 pm as instructed).
Monitoring
Monitoring the functionality is another disadvantage of automated systems since without a constant follow up with the system, you may not be able to find out if something needs to be changed.
For instance, in the case of no monitoring, the system might continue taking the entry time as 2 pm (as instructed by you) or any such particular time. But, you may need to change the time depending upon the situation in the market (your analysis/monitoring)
Conclusion
Automated trading is a contemporary practice that lets you trade more practically as compared to traditional trading. Moreover, automated trading is faster and more accurate when compared to manual trading.
In the blog, we discussed the main concepts such as working and how there is a thin line of difference between automated trading and algorithmic trading.
You too can get started with algorithmic trading right from the basics of what, how, why, algorithmic trading strategies and regulations for setting up an algorithmic trading business and much more in this Quantra course. Enroll now.
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