Trading Bots — How Effective are They?

Now, trading bots are part of many major exchanges and in crypto, and in the financial markets overall, 75% of all trades are made by automatic programs. In this article, we will explore how effective trading bots are, and should you use one?

What are cryptocurrency trading bots?

Source: coindesk

Offers for this type of machine are all over social media in South Africa. Most of these posts don't offer explanations on what they are selling. Trading bots are a colloquial term to what more precisely should be called algorithmic trading or trading using neural networks.

Here all of the steps that have to be made to trade are done by a program created with this purpose. The program will fetch historical data, select and use indicators, model future scenarios, and generate price predictions. Based on these, the program will place trades on the market using real money.

Now, not all trading algorithms are advanced enough to go through the entire process alone. Some can only do a limited amount and then a human takes care of the rest.

Even with the more sophisticated ones, a human has to oversee the process in case of bad results or errors in the code. Algorithmic trading is not automatic trading.

Some platforms such as e-Toro and others offer the possibility to pre-set buy/sell orders or create limit orders for assets. If the price reached this threshold then the order is executed, this is not algorithmic trading. These are just preprogrammed instructions made in a platform.

How do cryptocurrency trading bots work?

Once purchased, a trading bot will connect to the exchange via an application programming interface (API). At first, the program sits in the background gathering information from the market.

It logs all of the buy/sell orders and begins to construct models based on the activity. Then it begins placing orders of its own based on the data it gathered.

A trading algorithm, even from the same manufacturer, will be different depending on the information used to train it. This is why they are commonly called trading bots since the word bot is short for robot, and this reflects their autonomous nature.

Creating a trading bot is a very complicated process. Most of them are written in high-level computer languages such as Python, Julia, and others mainly used in statistics.

Behind one of these programs sits a complicated web of Econometrics, Set-theory, Algorithms, and many more applied sciences that make possible the operation of a trading bot.

Why use a cryptocurrency trading bot?

As with any trading tool, these programs are used to make money. But why use a trading bot of Technical Analysis?

A more traditional discipline used to predict price movements that can be applied by almost anyone. In contrast, the inner workings of a trading algorithm are only accessible to persons with advanced degrees in mathematics, computer science, or economics.

The most common answer is speed. Once a cryptocurrency trading bot has completed its training, it is able to place hundreds or even thousands or orders per minute. The overwhelming volume of trades serves as a hedge against price swings, as many of the trades are designed to balance each other.

This massive volume should result in a bot outperforming the market by brute force and not necessarily by being smarter. A person doing trades on a platform using technical indicators would only be able to place one or two trades a minute. So, it is not able to compete with the bot at this level.

Are cryptocurrency trading bots profitable?

This is a harder question to answer than it initially appears to be. There is a misconception at the core of it. A trading bot is not a magical A.I. to make money, it is just another tool. As such much of its performance depends on the user.

In review sites, the average performance of the major trading bots on the market ranges from 0.5% to 3% APY. A person with more expertise in financial markets is able to get 5% to 10%.

The reason behind this average performance is that a cryptocurrency trading bot depends a lot on how it is trained. If a knowledgeable person familiar with the mathematical models behind a bot pre-selects the data, then the program will outperform others.

A regular user who just connects the bot to the API of the exchange and lets it collect random data, won't have such an efficient machine.

Out of reach for the average Joe

Additionally, the best trading bots out there never make it to the market. If a programmer or mathematician develops a high performing trading bot, he has all the incentives to keep it. Or sell it to a major financial institution. Retail trading bots can never outperform those deployed by professionals.

So, yes a trading bot purchased at the retail level can be profitable. The real question should be, is it more profitable than other forms of trading? Or, can I recuperate my investment with 0.5% to 3% APY?

If you are a person with enough knowledge to get the optimal performance from the bot, then perhaps it is a worthy investment.

A regular user not familiar with the world of Econometrics and Set-theory won't have the expertise necessary to use this tool. In the end, this person may lose comparatively more money buying a bot, than if he just had traded using technical indicators. It is all about the opportunity cost.

Conclusion

It is important to not approach cryptocurrency trading bots with a naive perspective. These are highly complicated machines whose performance is tied to many factors that are beyond the average user.

As stated before, a trading bot is not a magical black box to make money. These are highly complicated programs whose performance greatly depends on the user. They should be viewed as another tool and not a magical silver bullet.

There are other forms of trading that are more accessible and in the end, can be more profitable. Just because algorithmic trading is the latest fad in cryptocurrencies, doesn't mean it is the best tool in the inventory.

For more on trading read:\
Crypto Day Trading in 2020: How to Day Trade Crypto