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 centralex 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.