In the rapidly evolving world of finance, trading methodologies have seen monumental shifts. One of the most prominent changes in recent years is the increasing adoption of algorithmic trading. But how does it stack up against the tried-and-true methods of manual trading? Let’s dive in.
What is Manual Trading?
In manual trading, the trader is responsible for making decisions about when to buy or sell assets, and then personally executes those trades through market or pending orders. Often, the trader will first explore multiple markets to identify profitable opportunities before taking any action. The quality of the trader’s results is directly linked to the quality of their decision-making.
For instance, a day trader in the Forex market might start their morning by examining an array of currency pairs. They may look for technical trading signals using various indicators and analytical methods. After identifying opportunities, they might place buy or sell orders themselves or create a watchlist and set up alerts to notify them when an asset hits a specific price point for potential trading.
Manual traders usually manage their trades by adjusting stop loss and take profit settings as market conditions change. In this approach, the trader is the one making all the decisions and taking the necessary actions.
What is Automated Trading?
In automated trading, a pre-set algorithm takes on the role of decision-making, determining what to buy or sell and when, based on pre-defined rules coded into its software. This could be the work of a trader, a programmer, or a ‘quant,’ who transposes a manual trading strategy into an automated system.
For example, a day trader in Forex might collaborate with a programmer to transform their manual strategy into an automated one. After running some tests, they may fine-tune the parameters if they find them to be either too relaxed or too strict. Once satisfied with the algorithm’s performance, the trader might first test it on a demo account before risking real capital.
Unlike manual trading, automated trading allows the trader to focus more on system optimization and strategy development, rather than the day-to-day trading tasks. Success in automated trading involves ongoing testing, refinement, and cautious roll-out of the trading algorithm. In this setup, the trader doesn’t need to be present to spot or execute trades. They can devote more time to enhancing their trading systems and creating new ones.
Understanding the Basics
Algorithmic Trading: Often referred to as algo-trading or black-box trading, it involves the use of computer programs and systems to identify and execute trades based on pre-defined strategies. These algorithms can evaluate market data at lightning speed and make split-second decisions that would be impossible for a human.
Manual Trading: This traditional method requires human intuition and judgement. Traders rely on research, market analysis, experience, and gut instinct to make their trading decisions.
Speed & Efficiency: With high-frequency trading bots, trades are executed in milliseconds, capitalising on short-lived market opportunities.
Eliminating Human Emotion: Algos act purely on data, removing the potential for emotionally-driven trading mistakes.
Consistency: Once set, algorithms tirelessly execute the strategy, ensuring consistent application.
Flexibility: Human traders can adapt their strategies on the fly based on emerging information or changing market conditions.
Intuition: Sometimes, the human touch can identify opportunities or risks that rigid algorithms might overlook.
Personal Risk Management: Manual traders can make real-time risk assessments that might be too nuanced for set algorithms.
Technical Risks: System failures or glitches can result in massive losses.
Over-Optimization: Relying too heavily on backtesting can create algorithms perfect for past conditions but not adaptable for the future.
Human Errors: Emotional or judgement-based mistakes can be costly.
Limited Speed: Humans can’t possibly compete with the speed of algorithms, potentially missing rapid market shifts.
What Stocks to Consider or Avoid?
For Algorithmic Traders: High-frequency trading bots often target highly liquid stocks like Apple or Amazon. However, they might avoid stocks with lower volumes or unpredictable news-driven volatility.
For Manual Traders: They might find success with mid-cap stocks where human insights can give an edge, but might steer clear of ultra-high-frequency traded stocks where they can’t keep up with the speed.
Both algorithmic and manual trading have their places in the modern market. While algo-trading offers unmatched speed and consistency, the flexibility and intuition of human traders remain invaluable. It’s essential for individual traders to evaluate their goals, strengths, and risk tolerance to choose the best approach.
A Deep Dive into Popular Stocks
Algorithmic Trading: Many algo-traders prefer stocks that are part of major indices such as the S&P 500, Dow Jones, or Nasdaq. The reasoning behind this is simple: these stocks tend to have significant liquidity, allowing for high-frequency trading without substantial market impact.
Tech Giants: Stocks like Microsoft, Google parent Alphabet, and Facebook are popular in algorithmic trading due to their high liquidity and predictable volatility patterns.
Financial Institutions: Big banks like J.P. Morgan and Goldman Sachs are also favorites due to their substantial volume and tight bid-ask spreads.
Consumer Staples: These are the goods consumers can’t do without, regardless of their financial situation. Think Procter & Gamble or Coca-Cola.
However, algo-traders tend to avoid penny stocks or those with erratic trading volumes. These stocks are not only illiquid but can also be manipulated easily, making algorithms less effective and riskier.
Manual Trading: Manual traders, particularly those with a long-term perspective, often focus on a company’s fundamentals, management quality, growth prospects, and industry dynamics.
Emerging Industries: Stocks in renewable energy, biotechnology, or novel tech areas can offer growth opportunities that require human judgment to evaluate.
Value Picks: Manual traders might also target undervalued stocks, hoping for a price correction over time. This could be in sectors undergoing temporary challenges, like airlines or tourism during certain periods.
Dividend Earners: Stocks like Johnson & Johnson or Unilever might appeal due to their consistent dividend payouts and stable business models.
High-frequency Trading Bots and Their Challenges
While algorithmic trading offers numerous advantages, the rise of high-frequency trading bots presents challenges, especially for individual traders. These bots can execute thousands of trades in a second, often leading to rapid price movements that can catch individual traders off guard. They often profit from minuscule price differences that don’t offer viable profit opportunities for human traders. Thus, while they bring liquidity to the market, they can also increase volatility.
The Role of Community and News
In manual trading, being part of a trading community can be beneficial. These groups can offer insights, share news, and point out potential opportunities. With the rise of platforms like Reddit’s r/wallstreetbets, we’ve seen the power of community-driven decisions and their potential to shake up even the most established market norms.
Moreover, news plays an indispensable role for both algo and manual traders. However, while algorithms can be set to respond to specific news keywords or trends, human traders can assess the broader implications of news, considering socio-economic or geopolitical factors that might not be immediately apparent to an algo system.
Trading, in any form, is a blend of art and science. While algorithmic trading is reshaping the landscape, offering speed and precision, the human touch in manual trading remains relevant. In the end, the best traders, whether they’re using sophisticated algorithms or relying on intuition, are those who continuously learn, adapt, and evolve in response to the ever-changing dynamics of the market.
Disclaimer: Remember, all trading involves risks. It’s vital to do your due diligence and consider multiple factors before diving into any trading strategy. If unsure, consulting with a financial expert is always a prudent choice.