Automated trading software can be categorized by market or user type. Trading funds use algorithms to trade stocks, currencies, and commodity futures, while individual traders often use retail software. Some retail programs offer a coding interface, while others use black box trading. Funds use testing to prove the effectiveness of their algorithms.
Automated trading software can be categorized based on the market it trades or based on the type of user. The general market types are stocks, commodities, and currencies. Users are individual traders or large trading funds. Individual traders often use retail software and funds develop their own.
The funds trade stocks, currencies and commodity futures using algorithms they have developed and incorporated into their automated trading software. The exact mechanics of these algorithms are carefully guarded. Stock trading funds often use so-called momentum algorithms, often combined with pair trading. Momentum algorithms take advantage of short-term and high-volume price changes. Pair trading means selecting two stocks in the same sector, then buying the stronger ones and shorting the weaker ones.
Forex trading funds can use algorithms based on the detection of price expansion and volatility in one direction. The price distribution characteristics of the forex market allow this approach to be successful, while it is marginal in stock trading. Momentum trading is used in some automated trading software that funds use to trade grain futures. At least one fund uses the physics of fluid dynamics to trade stock market futures.
Retail software, by contrast, tends to offer a pretty look on the computer screen, combined with the ability to place multiple orders simultaneously with the push of a button on the screen, and claim that this is “automated” retail software. . The trader is still required to monitor the market, decide which stocks, futures, or currencies belong in their button-traded basket, and then decide when to enter the trade. Some retail programs offer a coding interface that the merchant can use to write and test their own algorithms.
Another variety of automated retail software is known as black box trading. The algorithms used by the software are not disclosed to the buyer, and the buyer is often not given an adequate opportunity to test whether the software is truly profitable. Buyers are asked to accept on faith that the software has been profitable in the past and will be profitable in the future. Black box trading systems are offered to trade stocks, commodity futures, and currencies.
Funds using automated trading software amply prove this. They use bootstrap and Monte Carlo tests to see if the system is cost-effective in the lab. When they find algorithms that are successful in their testing regime, they test it in real time. Fund-generated software controls all aspects of trading: determining how much to trade, what to trade, and when to trade, and placing orders directly on the exchange. An individual trader needs to emulate the test of funds strategy to have a reasonable prospect of trading profitably.
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