We all understand that in trading, one side wins and the other loses. Then we change places: this is the law of the market. In other words, every trader, without exception, suffers losses at some point. To minimize losses and multiply the deposit, people began to use trading bots, which are often positioned as fast, automated, round the clock, flawless earnings. Sounds perfect, but is it really?
In this article, we, traders and software developers for automation and optimization of trading and risk management, will share with you our expertise in the field of trading bots, which can help you achieve excellent trading results.
Over the years we have studied DEFI index , trading strategies and traded and we can safely say that, indeed, bots can make money, but, unfortunately, their life cycle is limited (like any trading strategy). Trading bots die and fail - just like humans. Therefore, one day your bot may turn out to be ineffective, even if it has shown outstanding results for a long time. Remember: previous trading bot results cannot guarantee you a profitable future . Why?
First of all, you need to understand one obvious fact. The market is changing, and more and more people see the inefficiency of the market in which you earn (a certain dynamic, a pattern that can be used to make money), making it less profitable (the more people use it, the less profitable it is). That is why, after a while, any strategy or bot loses its effectiveness. In the case of trading bots, usually about 80% of the time it starts with a long-term "zero" profitwhich smoothly leads to losses. The remaining 20% of bots may surprise you with a sudden drawdown of the deposit, which exceeds all the limits you have set. In general, the profitability of trading bots is limited by a daunting range of risks, which differ depending on the type of trading bot. Let's consider what risks are inherent in different types of trading bots.
Arbitration bots
These bots trade unlimited coins / contracts on multiple exchanges simultaneously. As a rule, the profitability of such a bot is 20-50%. Impressed? And so do we. But it's worth remembering the risks!
Technical risk
The main one is technical risk. One of the exchanges the bot is running on may suddenly suspend trading, blocking arbitrage opportunities or interrupting your profitable trade. Result: you bear, one might say, unlimited risk, because instead of a neutral (hedged) position, you are simply a buyer or a seller. Also, in arbitrage, leverage is often used, which increases your risk significantly. Thus, your profitability depends a lot on the quality of maintenance and all kinds of errors that occur on the network.
Scalping bots / HFT bots
HFT bots (high-frequency trading) make a huge number of transactions with minimal profitability, constantly increasing your deposit. And here there are two news - good and bad. Let's start with the good one!
Good: over 80% of scalping trades are profitable, which makes technical risk less dangerous for these bots. They will quickly recoup possible losses, making them less painful for your budget.
Bad: There are several more significant risks for these bots:
Wrong position size
First of all, a scalping bot is a powerful machine, but only if you know how to use it. Often times, traders driven by greed will increase positions, eventually making them too large for the bot. As a result, the bot becomes absolutely ineffective (unfortunately, this is one of the most common mistakes many traders make). We'll talk more about ways to manage this risk in our future articles.
Faster Rivals
In addition, since scalping is a high-speed race for traders, your bot is extremely vulnerable to faster competitors (who, for example, use a better exchange access channel (connection)). Once you are overtaken, any ingenious strategy loses its effectiveness due to the speed of the competitor. And alas, you are losing again.
Pair trading, investment bots and bots working with indicators
All of these bots work by relying on a variety of time-proven models (historical data).
Pair trading is trading in assets that have a high correlation coefficient (direct or reverse), so the price movement of one asset can be predicted based on the dynamics of the price of another asset. For example, in the cryptocurrency market, there is a strong dependence of many assets on the price of Bitcoin - the correlation table shows high values. So, based on such dependencies, you can open opposite positions on related assets, hedging risks. Or, for example, if one asset deviates from its usual trajectory, when it begins to live its own life, one can assume that the relationship will soon be restored, and make a trading decision based on this.
Investment bots are about creating a profitable portfolio to ensure constant passive income. Bots select several assets for investment based on their historical performance and the ability to hedge risks together. So, they can compose a portfolio of high and low risk assets and change their ratio depending on the dynamics of the market.
Indicator-based bots also use historical patterns - price movements and volumes, and execute trades based on signals coming from indicators.
Let's figure out the risks for these types of bots.
Irrational market behavior
The key word and danger here is "past." All of these bots use historical price dynamics as a basis for making decisions. Yes, there are many lessons to be learned from history, but remember that time is not your best and only advisor. As soon as the dynamics of asset prices changes, the time-proven correlation disappears, as do patterns, signals, and so on. In such a case, the trader still hopes to get the usual profit, but suffers losses. In general, changes in price dynamics often occur at extremes: they are a common sign of upcoming changes in market conditions.
The same happens with indicators, which become useless even with a slight change in the behavior of assets. The logic of the patterns is easily broken, rendering the bot useless. As you can imagine, frequent changes are typical for the crypto world, where frantic volatility is the norm. For example, on March 13, 2020, Bitcoin lost half of its value, depriving even professional traders of deposits. Then how can we expect bot investing in the long run? The cryptocurrency market is changing at a breakneck speed, bringing in Black Swans, giving birth or killing assets in a matter of hours. Therefore, such bots are extremely short-lived.
Trend bots
Obviously, these are bots that work with market trends. We are talking about long-term trading, the analysis of market cycles. An example of the 4 stages of the cycle in the cryptocurrency market is given below:
Trend bots are aimed at catching huge market movements at the very beginning of their formation, that is, to determine the entry point at the right moment. If this happens, great! Expect a significant influx of profits to your account: having caught the second stage of the market in 2017, the bot would bring you about 300% + profitability (growth from ~ $ 5k to $ 20k! However, here we are faced with another problem: what to do if there is no trend at all ?
Inappropriate market conditions
Firstly, in the absence of a trend, we can linger in a long-term drawdown, because the trading bot is simply not adapted to earn sideways. Thus, you will suffer losses until the trend sets in (can you survive this period and not exit the game without a depot?). At the same time, keep in mind that you do not know exactly when the trend will start (psychological stress). The only way out is to obediently wait and hope to at least survive in this market. But there is one "but":
"The market can remain irrational for longer than you are able to pay."
(c) John Maynard Keynes.
Then ask yourself, are you ready (and can) be in a drawdown, for example, for half a year ..?
Secondly, being in a long-term sideways trend, you can miss the moment when the market condition has changed so much that the bot algorithms no longer work. Again, you will never know if your drawdown is “normal”, or perhaps something went wrong with the bot, which will miss the entry point, as the market conditions have changed too much.
And these are just some illustrations of the risks of trading bots. We don't even pay attention to other risks, such as, for example. a small mistake in the code that instantly kills any strategy, turning trading literally into giving away your money - you must admit, it's ridiculous and insulting.
Epilogue
So, are trading bots a guarantee of earnings or high risks? It turns out that this is both, and what you get in the end depends only on you. As you can see, each bot has its own set of advantages and risks, but bots themselves are unlikely to make you a millionaire. Therefore, their effectiveness can be equated to 20% contribution to your long-term profitability. The rest 80% of success is your comprehensive risk and money management, constant monitoring and improvement of bot algorithms! Yes, yes, this is about calculations, collection of trade statistics, detailed trade planning. We advise you to read about how hedge funds organize their work (they cannot afford losses!), And applying their principles in their trading - can simplify the process.
