Reducing Risk with Automated Trading
Reducing Risk with Automated Trading
When people talk about trading and risk, I find they often leave out one of the biggest risks to trading which is us and our emotions. The mental game of trading can easily end up being a trader's most significant risk or enemy. When I started my trading career, online trading was in its beta stages. All the volume and action was done by floor traders at the exchanges. The average person didn't have the option of "setting and forgetting" their orders with online trading, which helps reduce or eliminate emotional risk.
Emotional risk is strong and powerful. So strong that it has most traders and investors taking the opposite action of what they should take. For example, when the news is good, the trend in price is up, and indicators are spitting out buy signals, everyone wants to buy and most do. After all, that is how we have all been taught to buy into a market. However, most of the time when all that criteria is true, the price in that market is always high and typically at or near a price level where supply exceeds demand, which means you want to be a seller. Taking the opposite action of what most people are doing over a trading career can be emotionally challenging for traders to say the least.
Fast forward to today and not only is online trading very developed, but its functionality now does more work for traders than ever before. Not only can you enter an entire trade from start to finish at one time, you can automate your strategy and let the computer do all the work for you. Keep in mind that this is no easy task for aspiring traders, but it can be done. I want to share my trading statement from November 2 with you not to impress you with gains but more importantly, to impress upon you how important it is to reduce or eliminate emotions from trading with auto or semiñautomated trading.
Take a look at the chart below. The top yellow area on the chart represents a supply (resistance) level. This means that we assume that there is more willing supply than demand in that area because price could not stay there and had to decline from that level. Therefore, we want to sell at that price level if and when price revisits that level. A while later, price does rally back up to that level. The red circle is where I sold short with a buy stop just above the level, making it very low risk and high reward. Actually, I should say, the strategy sold short. From that price level, I expected price to decline until it reached a level where demand exceeded supply. The bottom yellow level is the demand level I am talking about. On the way down to that level, I took profits on the short position. Actually, I should say the strategy took profits on the short position.
Figure 1The point of this piece is that I really didn't do anything, the strategy did. I have an automated strategy that takes these trades. Not every trade is a profitable trade, some are losses which is fine. As long as your average profit is larger than your average loss and your winning percentage is decent, who cares about a win or loss, just run your profitable strategy. The computer took this trade and the computer doesn't care about anything. There was no stress selling after a rally in price, in an uptrend, when the news was good, the computer has no emotion.
Keep in mind, however, that what makes the strategy work and profitable is the proper set of rules. Without the proper rules, the technology will only speed up losses. Once you have the proper rules, however, the more you can let the computer do the trading for you, the better. You don't need an automated strategy, you can put your orders into the market ahead of time and use the "set it and forget it" approach that we advocate in the Extended Learning Track (XLT). Emotion is a big hurdle when it comes to proper trading and investing, let today's technology eliminate or reduce that ever-present risk. Lastly, who wants to sit in front of their computer all day? Not me!
Hope this was helpful, Have a great day.
- Sam Seiden
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