With the increase in access to information, rise in computing power, and desire for greater efficiency, automation has changed the way the world works. Trading is no exception and automations are used by many for greater transaction efficiency and accuracy.
While trading robots can substitute humans and are capable of employing trading strategies to make profits continuously, some traders still prefer to do things manually.
In today’s blog, we aim to objectively discuss both approaches to trading, highlighting the merits and demerits of each, with final verdicts of why each is preferred or recommended.
What is Algo Trading?
Algorithmic trading (also referred to as automated trading) is a form of trading that employs pre-programmed algorithms to execute decisions on when or what to buy and sell, all based on instructions written into their software.
In essence, a trader or software programmer may code their manual strategies so that when specific rules or events occur, the algorithm automatically executes trades.
Algorithms are dependable because of their programmed systematic approach to trading and problem-solving capabilities through mathematical and logic-driven execution.
They are able to take in and account for variables like time, price, and volume while sending small slices of the order out to the market over time so that traders do not need to constantly watch the market and perform repetitive manual actions.
Furthermore, algo trading minimises the cost, market impact, and risk during the execution of an order and is widely exploited by investment banks, mutual funds, pension funds, and hedge funds to execute large orders in markets that can’t support all order sizes at once.
Read more on algo trading platforms at Ortega Capital.
Algo trading merits
- Algo trading entirely eliminates human emotion from trading decisions, which is helpful to most new traders who struggle to stick to their trading strategy after a few losing trades. By using algorithms, traders can execute transactions in a more disciplined approach, based on a consistent and precise set of parameters.
- Traders can easily build a portfolio of different systems to handle different market conditions, thus diversifying their approaches. Where multiple indicators, positions, and pairs may have to be juggled by a manual trader, having a set of algorithms to apply each strategy allows the strategies to act simultaneously. Algorithms can also be backtested, enabling traders to quickly judge whether a system has worked historically and remain relevant.
- New investors can be easily influenced by stress around temporary price fluctuations, causing them to exit a trade prematurely. Acting on impulse can cost traders a lot in some instances of volatility. Algorithms act based on empirical information, allowing them to stay the course and stick to a strategy more easily.
- Algorithms are able to take advantage of short-lived opportunities in the market to generate quick profit through high-frequency trading, which is virtually impossible for humans.
Algo trading demerits
- The past doesn’t always guarantee future behaviour. Because an algorithm has worked historically, it doesn’t necessarily mean it will work in the future as market conditions and trends are always changing.
- Algo traders can easily be tempted to over-optimize their systems and change criteria to make their historical results look great, a practice known as ‘curve fitting’.
- It can be expensive to hire a programmer to code a trading strategy as extra optimizations or modifications may incur additional costs. This means that some traders may need to learn how to code, which can be tedious and time-consuming.
What is Manual Trading?
In the manual trading approach, traders make decisions on the price level to enter a trade and execute the transactions by themselves. This would typically involve studying multiple markets and news releases to identify executable opportunities, before placing an order manually.
Traders may also build a watchlist, setting alerts to inform them when a currency pair has reached a favourable price level for them to transact at.
Manual Trading Merits
- Traders can get in-depth knowledge about markets they are trading in, utilizing either technical or fundamental analysis in their decision-making.
- Traders have more control over what to do and when, they are able to recognise exceptions to the rule or able to formulate new sets of actions when new information appears.
Manual Trading Demerits
- It is highly time-consuming as traders need to perform extensive research, manually place their orders, and review their trades to achieve superior performance. It requires an extensive understanding of current information infrastructures, regular data visualisations, and comprehensive monitoring, which may be difficult and time-consuming in practice.
- Traders need to be highly disciplined in order to trade successfully. This includes being highly objective while taking profits and cutting losses and avoiding letting their emotions get in the way of decision making. This is necessary to ensure that the risk management plan stays on track regardless of the market situation.
- There is a level of subjectivity in manual trading as one can get the same signals but make different decisions each time based upon external variables they have to consider.
- The Forex market is open 24 hours and it is virtually impossible for a manual trader to be awake throughout every trading session to monitor the markets and trade.
Final Thoughts: What makes algo trading a better choice?
In summary, algo trading revolves around systematic approaches to trading where the foundations are based on mathematical logic, computation and precision. As such, price movements are programmatically analysed, with the execution being the intended outcome of the signal being met.
Algorithms are also able to operate at a much faster rate than humans, allowing precise and high-speed executions simultaneously across multiple instruments, freeing up time for other activities such as researching new trade ideas and optimising your existing trading strategies.
However, the algorithms can only perform what they are programmed to do and will only succeed if the strategy put in by the human has a winning edge. Also keeping in mind that all algorithms will decay over time, given that markets are constantly evolving.
In other words, algorithmic trading only works because of the manual foundation it was built on, and that it will continue to perform only if the programmer constantly review and adapt its strategy to keep up with the market dynamics
Our ability to problem-solve and adapt keeps manual trading relevant and necessary to develop better algorithms for trading.
The article is a part of our comprehensive guide on Algo trading.