The Spectrum of Automation
Welcome
Hello and welcome to our second article. This issue defines a range in the level of automation of trading strategies and explores some of the gains possible from increasing automation. All articles are saved at our Medium page.
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These articles are based on my experience from consulting and product development at The IQT. Do let us know if there are topics you would like us to cover, questions you would like to resolve, or if there are insights you would like to share from your own experience.
Last Time
In Article 1 — “What are Trading Systems and Systematic Trading?”, we discussed the terms trading system and systematic trading;
· These articles will look into various aspects of different trading systems
· The London Systematic Traders meetup group meets periodically to discuss strategies and approaches related to systematic trading
Overview
This time we will discuss the following:
1) manual and automated trading
2) the spectrum of automation
3) gains possible from automation
Main Points
1) Manual trading encompasses discretionary and systematic trading.
Automated trading encompasses systematic, algorithmic, quantitative and machine trading, but can also incorporate some discretionary decision-making. We will discuss these terms in Article 3 — “Buzzwords Demystified: Systematic vs Automated vs Algorithmic vs Quantitative vs Machine”.
When traders submit their orders, they can submit manually, i.e. by filling in a form in the trading platform for how much they want to buy or sell and at what price. By monitoring various charts on the platform, they can manually enter, manage and exit trades.
The alternative to manual trading is automated trading. Instead of filling in a form in the trading platform, traders use software programs to submit their orders.
· Programs are written in a trading platform’s programming language. E.g. the MetaTrader 4 platform’s programming language is called MQL4 (short for “MetaQuotes Language 4”).
· Automated trading can be seen as an extension of systematic trading, where the traders translate their pre-defined trading rules into a program.
Manual trading can consist of both discretionary and systematic trading. Automated trading is much more likely to be systematic but a hybrid approach can incorporate discretionary elements, as we will discuss in the next section.
2) There is a spectrum of automation, ranging from fully manual to fully automated.
Any component of the trading process can be made manual or automated,
discretionary or systematic.
To repeat from last week, the trading process in general looks like [we will explain this more in Article 4 — “A Detailed Look at The Trading Process”]:
Analysis → Setup → Entry → Management → Exit
There is a tendency to think that the trading process is either fully manual or fully automated. In reality, there is a range in the level of automation employed. Mimicking the spectrum of “parametric-ness” in statistical model estimation[1], we might define a spectrum of automation as in the diagram below, highlighting 4 key points according to their level of automation:
3) Manual traders can usually gain from increasing their level of automation to semi-manual or beyond
It can be argued that there is always a case for automatic identification of setups, whether fully or partly, i.e. manual traders can always gain from moving to semi-manual trading:
· Reach: by using programs to perform analysis and identify setups, they can set up alerts which can greatly extend their reach i.e. the number of markets and timeframes they can analyse at the same time. Then they can review all the alerts themselves and choose from the best setups to enter, manage and exit trades manually.
· By increasing reach, the number of profitable trades can be increased, leading to greater overall profits.
· Reliability: automation can also reduce the number of human mistakes (e.g. in analysis calculations), thereby improving the reliability and so profitability of trading.
Furthermore, there are gains possible from increasing automation beyond semi-manual trading:
· Reliability: again, automation can reduce the number of human mistakes (this time in entry, management and exit calculations), thereby improving the reliability and so profitability of trading.
· (Execution) Speed & Slippage: when manually trading, if humans do not submit their orders quickly enough they may not get to trade at the prices they wished — the price may move unfavourably, reducing the trade’s potential profitability. This is called slippage (in particular adverse slippage. Favourable slippage exists when price moves in your favour, this seems to happen less often).
Fully manual traders can also gain these final 2 benefits by making use of non-automated programs in the other trading steps, e.g. they could use custom tools created in MQL4 to set position sizes automatically when entering trades, as well as management displays to help them track their overall trade and account profitability (portfolio and risk management).
Further Reading
In Article 3 — “Buzzwords Demystified: Systematic vs Automated vs Algorithmic vs Quantitative vs Machine”, we will explore the different terms for non-manual trading, along with their differing nuances.
Thanks and happy trading!
[1] Nonparametric Estimation → Semi-Nonparametric Estimation → Semi-Parametric Estimation → Parametric Estimation
