The program will automatically generate orders based on predefined set of rules using a trading strategy which is often based on technical analysis but can also be based on input from other electronic sources. Automated trading systems are often used with electronic trading in forex trading for maximum profit pdf free download market centers, including electronic communication networks, “dark pools”, and automated exchanges.
Automated trading systems and electronic trading platforms can execute repetitive tasks at speeds with orders of magnitude greater than any human equivalent. Traditional risk controls and safeguards that relied on human judgment are not appropriate for automated trading and this has caused issues such as the 2010 Flash Crash. New controls such as trading curbs or ‘circuit breakers’ have been put in place in some electronic markets to deal with automated trading systems. ATSs can be designed to trade stocks, options, futures and foreign exchange products based on a predefined set of rules which determine when to enter an order, when to exit a position and how much money to invest in each trading product.
ATSs allow a trader to execute orders much quicker and manage their portfolio easily by automatically generating protective precautions. Backtesting of a trading system involves programmers running the program using historical market data in order to determine whether the underlying algorithm guiding the system may produce the expected results. Developers can create backtesting software to enable a trading system designer to develop and test their trading systems using historical market data to optimize the results obtained with the historical data. Although backtesting of automated trading systems cannot accurately determine future results, an automated trading system can be backtested using historical prices to see how the system theoretically would have performed if it had been active in a past market environment.
Forward testing of an algorithm can also be achieved using simulated trading with real-time market data to help confirm the effectiveness of the trading strategy in the current market and may be used to reveal issues inherent in the computer code. Live testing is the final stage of the development cycle. In this stage, live performance is compared against the backtested and walk forward results.
Metrics compared include Percent Profitable, Profit Factor, Maximum Drawdown and Average Gain per Trade. The goal of an automated trading system is to meet or exceed the backtested performance with a high efficiency rating. Improved order entry speed allows a trader to enter or exit a position as soon as the trade criteria are satisfied. Furthermore, stop losses and profit targets can be automatically generated using an automated trading system.
Automated trading or high frequency trading causes regulatory concerns as a contributor to market fragility. United States regulators have published releases discussing several types of risk controls that could be used to limit the extent of such disruptions, including financial and regulatory controls to prevent the entry of erroneous orders as a result of computer malfunction or human error, the breaching of various regulatory requirements, and exceeding a credit or capital limit. Although many HFT strategies are legitimate, some are not and may be used for manipulative trading. Given the scale of the potential impact that these practices may have, the surveillance of abusive algorithms remains a high priority for regulators.
FINRA has reminded firms using HFT strategies and other trading algorithms of their obligation to be vigilant when testing these strategies pre- and post-launch to ensure that the strategies do not result in abusive trading. FINRA continues to be concerned about the use of so-called “momentum ignition strategies” where a market participant attempts to induce others to trade at artificially high or low prices.