How retail investors can use algorithmic trading strategies
Not all of them know it, but algorithmic strategies can be a great way for retail investors to improve their returns. Whether you trade forex, equities, or any other asset class, using the power of automated strategies can simplify your processes and improve returns.
Say algorithmic trading and it normally conjures up images of high-tech, expensive operations run with whirring servers and complex coding requirements. Many retail investors still believe algorithmic trading is the preserve of major institutional players such as high-frequency trading (HFT) firms and investment banks.
In reality, algorithmic trading is cheap and easily available technology. Today, the use of a trading algorithm doesn’t even require programming skills on the part of the user. Many interactive tools now exist that allow retail traders to insert the rules and conditions for an automatic trade, and the program will then execute them in the market of your choice.
Traders and investors can then rely on the functioning of the algorithm to enter and exit positions according to these pre-set rules, removing both the risk of emotional mistakes and missed entry points. Of course, the other side of this is that traders are left with less customizability and cannot always double check each deal before it begins.
When to use algorithmic strategies
The best time to use these strategies is when you meet one of the following criteria:
- Too busy to check the markets all day. You might be missing opportunities that an algorithm will capture.
- Exiting winning trades early, moving stop losses, or other emotionally-driven errors. The algorithm can prevent this.
- If you find it difficult to stick to firm rules for your investment strategy.
In all of these cases, the benefit of algorithmic trading for retail investors is that it takes place according to clear, pre-set rules and requires no further input once it begins running. That’s not to say you can just ignore it – you should always check your portfolio to confirm trades are being entered and exited profitably and correctly.
When not to use them
Conversely, if you are a trader who prefers to intervene in your trades, algorithms may not be for you. Another danger is using algorithmic trading platforms without understanding the method behind them: always confirm you understand the parameters and how the algorithm works before buying in.
Retail investors who jump in to an automatic strategy without properly considering it may well regret it. Strategies can gain or lose money, in some cases quickly. Additionally some algorithms might have a specific function, such as mimicking the downward price movements of an index, that can be useful for professional investors but not so in the retail market. Always read through the strategy first and check any necessary information before committing your capital to the system.
How to use algorithmic strategies
Retail investors can benefit from algorithmic strategies simply by using one of the many trading bots available and connecting them to their online dealing account. Be careful when choosing a strategy, always confirm both the back-tested data and the live performance of the bot over a time period before committing. A good provider should offer all of this information as standard.
When selecting a strategy, choose one which aligns with your overall style. Do you prefer to make a few, large trades, or ‘scalp’ continuously? Your own financial goals are the same whether you use an algorithm or trade manually, so don’t switch just because its different.
Think about the required position size for each strategy. Can you commit enough capital to the system for it to be profitable? If not, maybe find a fund executing similar strategies that can bundle multiple user funds to reach the desired size. There is no point running a trading robot on such a small total sum that each position they open is only worth $20 – this will be eaten into by fees and result in very poor performance. Remember the example returns they give for a $1000 investment will require that amount as a minimum – they cannot be replicated with a $100 or even $500 sum.
Different asset classes
Algorithmic strategies work across all asset classes. Even so, they are particularly popular in forex. Retail forex traders benefit especially from algorithmic strategies for a number of reasons. Firstly, forex is uniquely responsive to technical analysis, that forms the basis for most algorithms. Secondly, volumes are very high so it is easy to enter and exit trades 24 hours a day, five days a week. Lastly fees are typically very low compared to commodities or even equities trading, meaning more of your gross return is preserved.
Specific advice for retail investors
The opportunities offered by algorithmic strategies are exciting for retail investors. That said, be careful not to be swept up in dramatic claims of great performance with no input. Technical strategies sometimes work for a while and then stop – you need to monitor the performance of your chosen strategy to confirm this hasn’t happened. Some draw-downs (reductions in value) are inevitable but if a long string of losing trades hits it is worth setting a point at which you will exit.
Some providers make exaggerated claims about their own performance. Check to see if the live strategy is living up to its billing – and be wary of claims of unreasonable returns. If there was a scalable strategy to return 30% per month consistently, no one would be sharing it with you. What claims like this likely hide is a niche, unscalable strategies, or worse still, fraud. Check the strategy’s performance over the longer term, and what kind of market conditions it does well or badly in. There is never an excuse to stop educating yourself about the markets, and it is a dangerous situation to start thinking of algorithms as a ‘money machine’.
Lastly, confirm the fees. Make sure there are no hidden or extra costs lurking in your portfolio. After a top-level fee, spreads should be the same as for normal trades. A trading strategy that profits each time a client places an additional trade has a clear motive to ‘churn’ portfolios unnecessarily. Be careful!