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The allure of automated trading
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The allure of automated trading

  #1 (permalink)
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The allure of automated trading

I think everyone can agree that day trading can easily be described as a dream job. Naturally, this is only the case if you are making money, but nonetheless trading gives you unparalleled freedom and control over your own destiny.

Having owned several businesses, I can also say that trading is even more liberating than being self-employed. If your small business requires interaction with customers (and whose don't?) or if you hired some employees to help with the work, then you've now got that "burden" which does not exist when you are trading.

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So, why is it that many traders want to take this incredibly desirable job and put it on auto-pilot? Yes, I am referring to automated strategies. I believe that most people looking to automated strategies for success are doing it for all the wrong reasons.

Here are two items everyone lists for reasons to automate their trading:

  • Can't watch every setup, miss some setups because I was afraid to pull the trigger
  • Program my strategy to follow my own rules precisely, because I can't be trusted to it discretionary
Sound familar?

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First, why do you care about missing some setups? How greedy are you? Or maybe more accurately, you missed good setups because you didn't pull the trigger and now you require more setups or maybe more excuses to trade. You need to be honest with yourself. Do you want to make $500 a day? $1000 a day? Fine, no problem. Those are my goals as well and they are completely realistic and can be accomplished with only a very small number of trades each day, usually just 2 or 3, for a couple points each. Don't be afraid to trade more contracts once you have a proven system. Usually people are only afraid to trade higher numbers of contracts because they have a pattern of losing. If you can't make money with 2 contracts then you aren't going to make it with 10.

Don't concern yourself with missing trades because really there are plenty of trades out there. Focus on being consistently profitable with two to three trades a day. Usually these trades can be had before lunch time, so you don't need to be glued in front of your computer the entire day, just 3 hours of it. If that is too much trouble then I think you are in the wrong profession, but please stay and keep trading so I can be on the other end of your trades.

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Second, automation has the appeal of being able to follow strict rules you set forth in your strategy. Most people go down this road because they couldn't be trusted to follow their own rules in live trading. Sure, their rules work fantastic when they look at a historical chart. But when they sat down at their desk and started to trade, all those rules vanished into thin air. At least they've come far enough down the road to realize the problem is looking them squarely in the mirror, and they stopped blaming it on the market.

Automated strategies are great at following rules. But they introduce a whole set of new problems which are nearly impossible to overcome. We know that 90% of traders lose money, and 10% take all 90% of the losers money. Now when you automate those odds are even more against you. Take it from someone who spent over a year, 8-12 hours a day, working on incredibly complex strategies.

Instead of focusing all of your energy on automating, why not focus on correcting the reasons you can't follow your own rules? I think it is fair to say most people who develop automated strategies already have a very strict idea in mind, a strict set of rules and principles to follow. They just can't follow them. So that is the real problem here, and that problem is far simpler to solve than making an automated strategy work.

Do automated strategies exist that make money? Of course. In fact, each year more and more of the market is traded with automated strategies. But should that really surprise you? Each year, are there more people in this world or less? Each year, are more individuals trading the markets or less? So just because more automation exists in the market doesn't mean that overall these strategies are making money. They fall into the same 90% losers, 10% winners as the rest of the market.

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My advice is simple. Seek out other ways to tackle what you perceive as obstacles in your trading, whether they are emotional, lack of time, or greed.

Mike

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  #2 (permalink)
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Thanks for the good words Mike.

"You can't automate what you can't do manually."

Brad from San Jose

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  #3 (permalink)
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Big Mike View Post
So, why is it that many traders want to take this incredibly desirable job and put it on auto-pilot? Yes, I am referring to automated strategies. I believe that most people looking to automated strategies for success are doing it for all the wrong reasons.

Nice post Mike. I've noticed in the past you are somewhat anti auto trading, and I understand why, but I'm going to make some arguments against your points. Firstly, above, well pretty much all of the features you mentioned are also available auto trading (plus some others such as lack of stress) Leaving apart the arguments for now about which one works better, you only miss the satisfaction of pulling the trigger yourself (but there are counter benefits)




Quoting 
First, why do you care about missing some setups?

Well, for me the reasons are - more setups gives a quicker, higher and more reliable return, and allows you to evaluate your performance sooner. This is really dependent on your method eh? There are methods such as you mention where missing setups really isn't that important. I guess auto trading allows you to be open to methods where it is an advantage to not miss setups. (Esp when asleep ;-)



Quoting 
Automated strategies are great at following rules. But they introduce a whole set of new problems which are nearly impossible to overcome. We know that 90% of traders lose money, and 10% take all 90% of the losers money. Now when you automate those odds are even more against you. Take it from someone who spent over a year, 8-12 hours a day, working on incredibly complex strategies.

Ah, this is why you're somewhat anti automation isn't it? They don't have to be so complex do they - most of the effort or work can go in the testing and tweaking. I know what you're saying though - if it's simple, the shark programs out there will mop you up. Is that what you mean by the odds are more against, otherwise I don't understand the basis for that statement.

Where we would probably agree, is that if you think automated trading will work off the shelf, or needs no more than a couple of months of dev and testing, then you're going to be disappointed. Most people probably don't have the skills, resources time or patience to effectively develop automated trading systems.

For those that do though, your reasons don't really apply IMO. I just think it's worth making that point in case anyone falls in to that category and was put off starting down the auto route.

Good debate.

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  #4 (permalink)
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Good thought-provoking post.

I think one reason that automated strategies appeal to traders is because of a desire for statistical confirmation of the trading method. If a robust backtest reveals a certain expectancy whenever conditions X, Y, and Z are present, you can't have any confidence that the same expectancy will apply if you vary from those conditions in any way. So automation is a way for the extremely statistical-minded to make sure they're trading a method they've tested rather than one they have not.

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  #5 (permalink)
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worldwary View Post
Good thought-provoking post.

I think one reason that automated strategies appeal to traders is because of a desire for statistical confirmation of the trading method. If a robust backtest reveals a certain expectancy whenever conditions X, Y, and Z are present, you can't have any confidence that the same expectancy will apply if you vary from those conditions in any way. So automation is a way for the extremely statistical-minded to make sure they're trading a method they've tested rather than one they have not.

If backtesting shows a method would not work in the past, it will definitely not work in the future. However, if backtesting shows a method would work in the past, then it may still work in the future when conditions X, Y and Z are present. I think a trader should know whether his method has a statistical edge. KNOWLEDGE to a trader (mechanical, discretionary of anything in between) is KNOWing his EDGE.

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  #6 (permalink)
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Being mechanical vs. automated?

I understand the thoughts about wanting to keep a discretionary basis for trading.

But what about being able to 'mechanize' your trading system? By that I mean, what if you define some setup based on a set # of variables.

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  #7 (permalink)
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Big Mike View Post
So just because more automation exists in the market doesn't mean that overall these strategies are making money. They fall into the same 90% losers, 10% winners as the rest of the market. ...Mike

Not trying to be picky ... lots of good points made, and some I disagree with on a personal bias ... but .. can you qualify the statement that 90% of automated systems fail? Are you referring to the # of systems or that they fail 90% of the time?

Jon

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  #8 (permalink)
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Please remember that post is almost two years old from my blog:

Big Mike's Trading Blog: The allure of automated trading

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  #9 (permalink)
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Where to start.

1) The only irrefutable in trading I've learned is that there are virtually no irrefutables. For every guy that swears "don't do this" there's a guy that makes a living by doing it. The lesson learned here is that successful traders use styles/systems that fit their particular mindset, experience, capabilities etc.

2) The main allure to automated trading is emotionless trading. There are many subsets to this idea. Firstly, automated trading allows a trader to enter/exit trades based on rules and remove most emotion from the equation.

There are 3 emotional events in trading. A) The entry. Should I get in? Are all my conditions/indicators met? Even the most simple strategies can feature fear or zelousy. Furthermore, the more sophisticated and vast your indicators become, an opportunity may be either diminished or totally gone by the time you sort it out.

Why would I be concerned about missing an opportunity? Because some systems use probability as the primary operator. For strategies that feature low win% (win Big, lose little) with modest returns, every opportunity is essential because the opp you miss is more likely to be a loser than a winner, however, if it IS a winner you missed, it has pretty adverse effects on your strategy returns. It blows people away when I tell them you can make money from a strategy that loses more often than it wins. For that to work properly, you HAVE to capitalize on every opportunity.

The next emotional event is profit taking. Should I take profits? Should I wait? Am I leaving money on the table? It's very tempting to stick around too long and get burned....automation helps to remove the dilemma and ensure your strategy (and you) STICK TO THE PLAN.

The next and most significant emotional event is the dreaded stop loss. Should I get out now? If I stick with it, will it come my way? I've personally seen traders burn themselves to the ground by compounding losing trades and meltdown months of positive gains in a few short moments. "reversing and doubling down" all sorts of irresponsible stuff.

A wise trader once said "Never cut a winner short, always give it sufficient time to bear fruit. Never add to a loser, take your loss and move on to the next trade." The ability to recognize the difference is what separates wealthy/successful traders from bankruptcy.

Automated systems allow me to backtest new ideas and allow me to gain thousands upon thousands of hours of experience where manual trading would require me to actually experience all of it.

Automated systems reduce watchdog fatigue. If you're trading style is news/event driven, then watchdogging is easier (like most stock traders). If your strategy is technical, then automation helps to keep you from turning into a zombie. Obviously, most of us try to craft strategies that optimize certain aspects....ratios, profit factors, drawdown, etc. Time in the market is one factor. All things being equal, less time in the market is better. If you can make the same returns but spend half as much time in the market (exposed) that's a good thing. But that comes at a cost....as your time spent endlessly watching charts increases. Automation helps.

There's a lot more to automation than most people realize, which is why it gets a bad rap. I know of guys who have little/no risk management incorporated. I personally ensure that I have SEVERAL layers of risk management, from the strategy and coding itself, to dedicated servers in a location with maximum guaranteed uptime, to having the trade desk on speed dial, to redundant phone and internet systems. Secondly, it takes months to adequately test and verify a strategy. There's a lot of guys who test for a week, backtest and away they go....

As I said when I opened, if it works for you, go with it. As I always say with guns, calibers, etc....shoot the gun/caliber that you do the best. What good is the most bill-baddo gun if you can't hit what you're aiming at? Some people NEED automation. In fact, I would venture that ANY modern trader uses some level of automation. A simple "order cancels order" or supplemental order is, by nature, automation. I can do things with money management that no manual trader ever could....hundreds of calculations a second for custom trailing stops, multi-tiered stops, profit harvesting, etc. The largest/most volitile markets move way too quickly to sit and constantly calculate and recalculate profit percentages, previous volumes, etc. Automation opens up a whole infinite world of indicators and money management tools.

I think your post (as old as it is) refers to the guys who think that instead of "cruise control" (which still requires you to be awake at the wheel) that they can simply apply a "auto pilot" and go golfing/skiing. I personally could not stomach the stress of manually day trading...it was enough to drive me to smoke/drink. Automation helps me to smooth that emotion over and reduce the operable challenge to research, hard work, backtesting, creating new ideas and indicators and analysis tools, etc. I now win/lose based on how well my strategy predicts market movements, not how stone cold and disciplined I am.

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  #10 (permalink)
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Yeah, I like my rigby 416 the most.

Tell to HFT companies who have with a team of 20 people more than $300million profit a year (according to Bloomberg magazine) that automated trading doesn't work.

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