As automated trading becomes mainstream for retail traders, we want to ensure that expectations are appropriately set. Particularly, why we believe that automated trading does not mean unattended trading.

To help guide and frame this conversation, I invited our Chief Market Strategist, Ryan Hysmith, back on the show with me. Inside we'll talk about the future of automated trading, if automated trading provides an edge, and what some of the possible downsides to automated trading might be that you should carefully consider.

The Background

Read the Option Alpha blog Ryan wrote called “Automated Does Not Mean Unattended." This article was sparked by a Quora post that had the following opinion on the topic:

“Automated does not mean unattended. Even with fully automated systems, you watch them all day and constantly look for improvements, potential problems and tweaks….There is a multi-billion dollar industry around algorithmic trading, much of which could be said to be fully automated. In reality of course, automation has its limits. The idea of individuals sitting at home, constructing magical trading systems on their spare time which would allow them to sit on the beach all day while their home computer harvests money, is a myth created by all the vultures selling junk trading systems and 'mentoring' to the unsuspecting retail segment….The problem that makes most fail at automated trading is that they aim for the impossible. They buy the myth about triple digits compound returns and other silly things that cynical snake oil salesmen try to push….Aim for low digits compounded returns over time and you'll have a much greater chance at success.”

What Automated Does Not Mean

Automated doesn't mean inactive.

Automation does not allow you to "set it and forget it." Instead, automated trading frees you of the more mundane aspects of trading, thereby elevating your thinking beyond the day-to-day tasks, allowing you to focus more on the strategic sides of trading.

Two Types of Trading

Long-term trend trading strategies don’t require a lot of tweaking. For the most part, you could ignore what a strategy like this does for months or years at a time. These strategies tend to be reliable and usually start to fail when people come into the equation and make emotional decisions that run counter to the strategy. Here, automated trading could free people up to watch the strategy less, be less emotionally invested, and let it run its course.

On the other side, there are different shorter-term approaches. Here, the trader is like a coach at a game, choosing players based on their skills to match different scenarios.

From an autotrading standpoint, you can use your bots like chess pieces, where you consider the overall strategy and switch different tactics on and off depending on what works best for the current conditions.

Learn How to Trade First

Auto-trading does not mean people can jump into trading without understanding how it works first. If you don’t understand trading, you can easily make a mistake with setting up your automations. Only with a thorough understanding of trading will you be able to catch errors you might make with how you set up your automations.

This is why it is a good idea to learn trading and auto-trading using paper trading.

What Does Automated Trading Mean

There are a lot of mundane, monotonous tasks in trading that suck up mental bandwidth (getting orders filled, entering positions, etc.). These are the tasks you can delegate to your bots so you can free up your mental energy to focus on big picture strategy.

Getting Clearer on Your Strategy

For many people, the challenging part about automation is that you have to translate the strategy you use without automation into a system. While this is difficult, it will help you clarify your approach and stress test your system. It allows you to think about the higher-level concepts around strategy optimization that maybe you subconsciously ignored previously.

The fact is there are some things about your strategy that you should not touch. If you determine that your position sizing should be 2%, that's a great thing to offload to a bot and an automation. Many people say they won’t touch a part of their strategy and then over-allocate in special situations. Automation can help curb these impulses.

Does Automated Trading Give You An Edge?

Automated trading will help you do what you're already doing more efficiently.

Remember, automated trading does not make you a better trader. If you take a lot of risks and have an ill-defined strategy, automated trading will probably lose you a lot of money. If, on the other hand, you have a solid strategy and want to set better rules, automated trading will help you stick to those rules.

The Opportunities Templates Present

Templates have given us the ability to “learn” new strategies quicker than ever. To understand and process a strategy that is taught to you or that you research can take a long time, and you can't even be sure that you have interpreted it and applied it in the same way it was taught.

Templates, and the opportunity to share templates, give you a framework of the core foundational elements of what that trader meant the strategy to be.

This is powerful when adding, improving, and optimizing what you're already doing much faster than you could have done on your own with limited time and limited capacity to understand different strategies.

Finding A Net Positive Edge

The things you're going to take advantage of with automation have to outweigh the things you have to give up after switching.

Switching to an automated strategy means you give up that ability to do one-off trades. This is overshadowed by all the positive things that you get from an automated strategy, in our opinion.

Switching to an automated strategy means you give up a little bit of what you may think is very important control. We would argue that that is not as important. What you give up, the minor tweaks, and so on, are not as important as consistently running the system the way that you should run it. And you still have control over all the bot's settings.

When exiting a position, some people might say, "Well, I'm going to exit this position this exact way at 12:00 in the afternoon." Whereas, maybe the bot exits the position for a slightly smaller profit at 2:00 in the afternoon, because that's when the triggers lined up to exit the position. You would look at that, and you'd say, "Oh, well. I could optimize this a little bit better if I watched it all day."

This is true, but you're forcing yourself now to watch it all day. Inevitably there will be days where you can't do this. What happens the day that you don't watch it and the market crashes at midday? The bot could have exited, but you didn't because you're trying to make these tiny tweaks that don't mean a lot in the grand scheme of things.

Yes, you're going to give up the rush of finding a great opportunity during a market move. However, what you receive in exchange is more consistency and systematic trading, as well as opportunities that you passed on or couldn't execute at the time.

Trader Q&A:

“MEMBER: Hi. My question is, if we know the probability of doing a credit spread at 70%, and a debit spread at 70%, and an iron condor at 70%, why would we not trade all three of them?”‍