A large portion of FX trades are now executed automatically, following pre-set parameters determined by an algorithm. At the same time, many manual traders continue to execute trades when they decide to, guided by their strategy but making the ultimate decision. In most cases, the differences between the two methods have been exaggerated – a manual trader following a pre-set strategy to the letter is not functionally different from an algorithm, and it is possible to add as many caveats and additional data points to an algorithm as you can think of. But in certain specific cases involving technical analysis, the two styles function quite differently. The most notable of those are styles such as HFT or scalping, or news based trading.
The growth of algorithmic trading began decades ago, but the 2010s saw considerable consolidation, as well as the development of new styles of algorithmic strategy such as HFT. Many of these algorithmic strategies use technical analysis to enter and exit trades, but they do so in a way that is quite different to traditional, manual trading. Competing on strategies that require speed with a machine is unwise, so it is important to understand the different ways that algorithmic strategies use technical analysis. Retail traders also use these strategies, both for backtesting and also automated execution of trades. This comes with both advantages and disadvantages, described in detail below.
Algorithmic and manual trading
Algorithmic trading refers to trades executed automatically by a computer program. These strategies are quite prized because they allow traders to execute according to exact parameters, quickly and without the risk of human error. Manual traders prefer to have human oversight of each trading decision, which can be a benefit for experienced, disciplined traders, but in many cases can lead to human-led error.
When designing a trading algorithm, traders will run backtests with the same parameters they intend to use going forward. The algorithm includes instructions to execute trades when specific conditions are met – for example to go long when the 15-day moving average crosses the 30-day when the RSI is below 80. Eagle-eyed readers will notice that this is exactly the same as how manual trading strategies work: the only difference is automatic execution.
Not all algorithmic trading competes directly with manual trading in this way. There are some market niches that can be uniquely exploited using a combination of technical analysis and algorithms. For example some scalping strategies may be executed at very high speeds using automated trading, trading extremely small price moves and using leverage to make them profitable. This is not a strategy that can be easily replicated by manual traders, since they are at an immense disadvantage in terms of speed.
Differing uses of technical analysis
Asides from the speed of analysis and execution, manual vs automatic strategies often use different indicators. Part of this is due to the prevalence of scalping strategies in automated technical trading, which can use small price fluctuations to quickly enter and exit positions. Other chart types are more subjective, particularly candlestick patterns. These resist hard and fast rules about pattern formation and entry / exit points, and so are more popular with manual traders and neglected by algorithms.
Where can manual traders find an advantage?
There are a few things to remember when it comes to operating in a mixed manual / algorithmic trading environment.
- Algorithms have an enormous advantage on speed and precision.
- Some algorithmic strategies are identical to manual strategies and offer no real advantage except they don’t allow human interference.
- You must use the most appropriate execution method for your strategy; no style has an advantage everywhere.
In most cases, interfering with your pre-planned strategy is a mistake. Interference makes it harder to judge the performance of your actual strategy, and can change the real parameters of how you trade. This nis especially true if you find yourself deviating from your strategy regularly.
However, it is also true that sometimes manual oversight can prevent disasters. Algorithmic technical strategies tend to ignore news events and other external influences that a manual trader will think about. It is possible to produce an algorithm that responds to the news, but it will only do so in repetitive simplistic ways. Because the average trading algorithm is quite simple, it does not take into account general market conditions, large portions of the price data, or any fundamental metrics, things which any well-informed trader will continually be aware of. The largest quantitative funds use immensely complex proprietary algorithms to try and include every possible input – this is an interesting idea but probably impractical for most retail traders.
Different cases
The above situation often does not apply: traders should be careful not to use manual strategies where they are at a clear disadvantage to their automated cousins. Asides from the obvious example of HFT, news-based strategies are highly speed dependent. That doesn’t mean that manual traders cannot deal based on the news, less still that they should ignore it, but they must be aware they are at a disadvantages when trying to respond immediately to new developments.
Interchangeable strategies
We have touched a few times on the point that often manual and automated strategies are effectively the same. This of course does not apply to subjective manual strategies, or to high-speed automated ones, but there is no real reason an algorithm along the lines of:
When RSI <80, if 15-day moving average > 30-day moving average = Go Long
When RSI >80, or 15-day moving average < 30-day moving average = Close position
Should return different results for a manual versus automatic trader, assuming he lets the strategy play out. At this point it comes down to your personal preference or confidence in your own trading psychology; given that traders can switch off or edit algorithms, the most determined to interfere will not be stopped by them.
What traders need to understand is the different situations where algorithms and manual trading may or may not be interchangeable, and if they are dealing with one of the cases where technical analysis must be used differently, to do so. A short, non-exhaustive list of such strategies includes:
- HFT,
- Scalping,
- News trading.
Each of these strategies involves speed, relying on rapid analysis of the technical data to produce a trading signal. In all of these cases, algorithmic or automatic traders will have the advantage. Three examples of technical strategies where manual traders may have the upper hand:
- Candlestick chart strategies,
- Approximate support and resistance levels,
- Combined technical and fundamental strategies.
In each of these, there is more data to process, decisions can be made slowly, and above all there are subjective elements such as candlesticks which cannot be so easily codified. Here algorithmic traders will not have a speed advantage, though they will still outperform undisciplined traders who cannot stick to their own strategy.
How Rakuten can help
There remain opportunities in the markets for both manual traders and algorithmic, and in many cases their trading styles are simply the same with no real advantage either way. One way of testing a trading strategy is paper trading, so why not open a free demo account and start trading today without risking any of your capital?