It has been centuries since the Dutch East India Company made the world’s first initial public offering in 1602. With this, VOC became the first company whose shares were publicly traded. In the last phase of more than 400 years of development, a new kind of tool has emerged and evolved to take advantage of market movements: automated trading software. Even today, many people aim to master the art of professional trading, but does it still make sense?
There may be several motivations behind buying stocks or other assets such as cryptocurrencies. Some people, thinking of a long-term investment, start buying assets to achieve a future goal. Some simply want to defend themselves against inflation. And also one who wants to get higher returns through price speculation. One thing is for sure: every market participant does what they do for the sake of greater profit. In the early 1900s, it could only be traded locally on the stock exchange. This changed in the 1990s with the advent of the electronic communication network (ECN), after which speculators could trade outside the actual market. Thanks to the ECN, the industry is still in shape today. The declining exclusivity of the industry has made it possible for retail traders to get into the game from home, with their own strategy, with their own knowledge.
Human traders have developed a number of analytical methods. The assets are analyzed both fundamentally and technically. It is generally accepted that long-term success requires a trader to spend several years or even decades learning. It is not enough to master the methods of analysis. One has to constantly struggle with one’s emotions. You need to push greed and fear into the background. And you have to adopt patience as your best friend.
In the 21st century, algorithmic trading began to develop rapidly. The advent of the ECN has also brought with it the exploitation of computers in finance. Algorithmic trading means that according to pre-programmed parameters, a computer program gives buy and sell orders. Trading algorithms first appeared in the 1980s and used the so-called index arbitrage strategy on the S&P 500 index. The strategy worked like this: the market is shaken by some event that causes it to move. Not all stocks in the index will react at once. The so-called laggers lag a little, but the arbitrator can expect them to bring in the lag later, so it’s relatively safe to buy from them.
In the 20 years since their appearance in 1980, algorithms have turned to a corner of market volume, but they were still in a minority. In 2003, circulating algorithms accounted for only 15% of market turnover. Just 10 years later, that number is already 85%. This means that in 32 years, trading algorithms have become the dominant players in trading in 32 years, less than 8% of the life of the stock market, pushing people into a minority.
The world’s largest hedge funds also prefer to use algorithmic trading. Bridgewater Associates founded by Ray Dalio, Two Sigma Investments and Renaissance Technologies all rely on technology to make their investment decisions.
The startup scene also seeks to ride the democratization of investment. The service provided by hedge funds is only open to large investors, but FinTech startup, b-cube.ai wants to provide a solution for this. The company develops automated trading bots with technology similar to hedge funds, but also available to retail traders.
What are the reasons for the popularity of algorithms?
No emotions involved
Analysis and execution in the case of an algorithm is not controlled by man, but by a computer program. Automated trading has several advantages over humans. We mentioned earlier how difficult and long it is for a person to control their emotions. The bot, on the other hand, does not feel and always executes the programmed commands precisely. This trait is in itself a priority that represents an unimportant advantage over many traders.
To trade successfully, we need a so-called “edge”. The edge is an advantageous situation that recurs and by playing it we will have a statistically higher chance of winning, so in the long run, our account balance will turn into net positive. This does not mean that we are successful every time. Sometimes we encounter a situation that looks the same, but the end result will be different. How we decide to repeat is critical to our long-term success. The key is to decide according to the strategy every time, which often means that we have to do exactly the same action. If we deviate from the strategy, it also means that we do not follow the strategy, so it is not possible to measure its results. Inconsistent traders bleed in the market. However, the merchant algorithm is always able to perform the same action according to its code. This makes it perfectly consistent in rounding.
From the strategy, the user needs to make sure how he will perform live. This is called the backtest. This means that the computer will test historical price movements for how our strategy would have worked. The backtest is also done by the manual trader, mostly the same way he trades: manually. Unfortunately, this takes an extremely long time even if we only test a few trades. The algorithm can perform hundreds or thousands of past tests in a relatively short time, up to a few minutes.
Who is better?
How you will trade in the market, what will be the edge, you still have to figure it out. The peculiarity of man is trading from intuition. Advanced intuition is the result of experience. One will get better at trading over the years and acquire an ability, similar to athletes. However, there are no talents who would be “pros” after the first few trades. Several statistics confirm the fact that 80–95% of traders lose in their trading. This makes it clear that it is not easy to build a livelihood from trading. And the lucky few percent spent a lot of time developing their skills.
If someone is starting to trade now, choose manual trading only if they are committed to the next 10 years and are not afraid of losing. In addition, it is worth starting automated trading. This does not mean that success is guaranteed there. The algorithm is just as good as its code.
Trading cryptocurrencies involves risk. The information provided on this website does not constitute investment advice, financial advice, trading advice, or any other sort of advice and you should not treat any of the article’s content as such. Author, website or the company associated with them does not recommend that any cryptocurrency should be bought, sold, or held by you. Do conduct your own due diligence and consult your financial advisor before making any investment decisions.