Algo trading is a trading style that has many advantages over discretionary trading. One of the most significant is that all orders are executed by a computer, relieving traders from their decision making role. For many traders, self-sabotaging costs a lot, and if mistakes and irrational behavior could be minimized, they would save large amounts of money.
However, letting a computer trade for you is not risk-free. Here are 10 mistakes that are often made in algo trading:
1. Not Anticipating the Unexpected
In trading, everything can happen. Your internet connection might go down, your servers might crash and there is a possibility that the exchange as a whole will experience technological issues. While many events of this kind are unlikely, they will most likely happen sometime. That is why you need to be ready for everything! Do not risk more than you are willing to lose, and make sure that you never take on more risk than your account can bear!
Remember that it could only take one black swan event for you to never be able to trade again! Do not let this mistake end your trading career!
2. Disregarding Trade Journals
Having a trade journal in trading is important, regardless of whether your trading is discretionary or automated. Apart from what many believe, all emotions are not subdued by trading automatically. Having a journal enables you to learn from your mistakes and become a better trader with time.
3. Trading the “right ” things
Markets are living organism. They change with time, acquiring new habits and traits, and so should you with the market. It is essential that you never let any preconceived thoughts about how things should be dictate what you test or trade. The truth is that what is easily available and widely used, often does not work very well. To make money from the markets, you need to be original and test things that nobody has tested before. Quite often you will find that the very opposite of what is widely recognized in trading works the best!
4. Not Including Slippage and Commission in The Backtest
A common mistake made by beginning traders when backtesting, is that they do not include slippage and commission in their backtest. You would be surprised how many small edges that look perfectly tradable, but fall apart completely once commission and slippage are taken into account!
5. Thinking “this time is different”
The world has never been more peaceful than it is right now. However, when listening to what is reported in the media, it is hard to believe.
The same applies to trading. If you always find excuses to stop trading because something is worrying you, the chances are that you will miss the profits and embrace the losses. Always follow your trading plan and prepare what you should do in critical moments! That is the easiest way of avoiding mistakes!
This time indeed is different, but also the same.
Overtrading can have many connotations. Placing too much leverage on a trade is one of them. Taking too many trades by trading too many strategies is another. If you place too much leverage or capital on a single trade, you risk losing a dangerously large portion of your account. Experience several losses of that kind in a row, and you will soon be out of the game!
One detrimental mistake that you should avoid in algo-trading is being overly confident. Some novice traders may experience some ‘luck’ with minimal effort on the debut of their algo-trading venture. At times, this ‘luck’ may make them overconfident leading them to take on too much risk. Humbleness is key to trading success!
8. Not Using Stops
One big mistake made by beginning traders is that they have not set their stops before trading. Stops are needed to limit risk and should be placed both on the strategy level and trade level. If stops are not a part of your trading, you run the risk of letting losses grow too big and become hard to recover.
9. Interfering With the Algo-trading System
One of the main reasons why people algo trade, is that they want to remove human subjective input and replace it with the objectivity of a tested algorithm. In the event of a large drawdown, you may feel an urge to intervene. Do not do that! Your edge lies in your strategy, not in arbitrary decision making!
10. Not Treating Your Trading Like Business
Imagine telling someone about how you owned a big business yet you have no record of your average sales, inventory, the average price of best-selling items, the average time that most customers trickle in, etc., etc. Everyone would think you’re a great fiction story-teller!
For the simple reason that you cannot run a business without records, you also cannot trade successfully without keeping records. It is a business just like any other. It is crucial that you keep records so that you can learn what works and what doesn’t. This includes positions to hold, securities to trade in, how much leverage to put, etc. The analysis of your computer and trading system accounts for just a bit of your success as an algo-trader. The major part is on your personal participation, and that’s where records come in handy. You will be able to ascertain your trading strengths and weaknesses. With these, you can maximize on the former while minimizing the latter. You can be able to rationally make an informed decision based on your previous judgments. It can also help you understand your trading persona hence giving you a chance to evaluate why, when, and how you tend to trade in a certain way.
Many traders assume that they can never make mistakes with algorithmic trading systems owing to their computerized nature. But the above consideration highlights some 10 mistakes commonly made and of which should be avoided. We hope that you will guard against them in your trading endeavors. Happy trading!