Are Trading Bots Profitable?

The investment sector is going through one of its most disruptive periods in history. The fundamental concept of investing is being revolutionised thanks to a new wave of disruptive technologies, evolving from a relationship-driven The investment sector is going through one of its most disruptive periods in history. In fact, the fundamental concept of investing is being revolutionized thanks to a new wave of disruptive technologies; evolving from a relationship-driven practice exclusively accessible to the wealthy to a more democratized activity serving a much wider consumer base.  

The concept of automated trading has been around for decades, but trading bots have soared in popularity due to their ability to simplify the trading process. It has become mainstream for people to learn to trade many different kinds of assets, and where self-taught traders lack the time and resources to learn, advanced trading technologies like trading bots have helped save time and make trading much more efficient. We are seeing more and more investors – both institutional and retail –investigate the potential value of incorporating more of these advanced technologies into their trading strategies to maximise profits. But, are trading bots actually profitable? Read to the end to get a comprehensive overview. 

Before diving into their profitability, let’s recap on what a trading bot is, exactly.

A trading bot is a computer program that connects to a user’s exchange and conducts trades for them, at the optimum time, for the best possible outcome. They use artificial intelligence and machine learning to observe the market with a given set of instructions or rule criteria to act on, for instance: “buy X amount of Y if a certain price target is hit”. Once that criterion has been hit, the bot will automatically execute the desired trade. This is great for traders who often go to sleep and wake up to realize they missed out on all the best trading and market opportunities. The concept behind them is fairly straightforward: to help investors save time and make money in the markets. The goal is for the bot to generate a profit and for that profit to be greater in terms of risk adjustment than it would be if the investor had attempted to do it on his own. Therefore, mere “high returns” aren’t the goal – the real goal is high risk-adjusted returns (profits gained relative to the negative gains you’ve suffered). The premise is that computers are better at trading and generating higher risk-adjusted returns than humans could ever be. 

Whether this is true or not, evidence suggests that the majority of traders – especially newbie traders – who are using bots lose their money and fail to outperform the markets. Why? 

There is a common misconception that trading bots are a money-making machine. Lots of traders go into it thinking that all they need to do is buy a bot, switch it on, and sit back while the profits roll in. However, if you don’t understand the importance of market conditions and how they could affect your trading, then you’re going to lose money.  

Even if there are sophisticated automated trading strategies out there that work, many people entering the markets are looking for huge returns but lacking a thorough understanding of technical analysis, back testing and custom strategy building. The fundamental issue is that there is a significant gap in expertise between professional investors and the more experienced algorithm builders who create them for the general public. 

You need to have some market know-how when utilising them. It still requires a lot of work, and you have to constantly tweak your trading strategy. Without experience, you may not witness the full extent of the bot’s profitability. 

That is not to say that trading bots are a bad choice if you want automated trading strategies. Indeed, they are an important development in democratizing the investment industry and can help you achieve positive returns. 

Here are some characteristics that can have a positive impact on your trading performance:

  • Endurance. They enable you to trade 24/7 and execute trades in your sleep. Many investors are unable to react rapidly enough to market movements in order to gain the best possible profits from transactions.  
  • Capacity. Robots can process gigantic amounts of data per second – something humans quite simply cannot do.  
  • Emotionless. They take the emotion out of trading. All you have to do is set the criteria and let them do their work, so you will be less susceptible to panic selling and the ‘fear of missing out’. 
  • Back testing.  They allow you to back test your trading strategy, meaning your bot can take your current strategy and apply it to historical data and tell you how successful it is. 
  • Simplicity.  They simplify trading. Bots can access and carry out multiple trades across multiple different exchanges.

While there are successful firms developing professional, profitable trading bots out there, there are also some marketplace risks to be aware of when considering trading bots:

  • False impressions. Due to over promotion with regard to easy profit, many are under the impression that trading bots are magical money-making machines that churn out profits all day.  
  • Overselling and underdelivering. Lots of so-called “expert” developers over promote the success of their trading bots, but the truth is, their bots lack sufficient testing and the developers lack true expertise in the financial markets. Nevertheless, there are experienced trading bot developers in the market place, but to be able to be profitable in the long run, they need to constantly be improving the trading bot. 
  • Monitoring. They still need to be monitored. As the market is cyclical, trends will come and go all the time. Bots can therefore not be a substitute for being a knowledgeable trader with a solid supporting investment plan. In order to emphasise the importance of monitoring, in our case as a company, we monitor over 7000 bots monthly in order to identify bots that don’t perform as expected. 
  • Fees. A factor that can influence your profitability is fee requirements. Your transaction costs (bid offers) and trading costs (payments to the exchange) can significantly impact how much profit the bot makes. 
  • Successful track history. There is a lack of data backing some trading bots or algorithms and a lack of evidence that these automated trading bots can outperform the markets. Make sure that you see proven audited results of the claims made before investing your money.  

What options are out there?

  1. Open-Source Scripts 
    You download the source code, compile it, connect your exchange keys, and you’re ready to go. They’re also very configurable, and you can set your own indicators. 
  2. Paid Platforms 
    There are many trading platforms available that you can pay for in order to use their bots. Normally, you would pay a monthly fee to access the platform, select which of their bots you would like to run, and then turn them on and off as it suits you. 
  3. Build Your Own  
    If you have knowledge of trading the markets, then there are platforms available that provide you with easy-to-use software that allows you to set specific criteria and build your own trading robot.   
  4. Funds 
    You can also choose to leave your money with traditional quant funds. Most of these options tend to cater to HYWI. 

Let’s explore the profitability of each to find out which one brings home the best risk-adjusted returns. 

Firstly, open-source scripts. It is a widely accepted claim in many trading circles that “nobody would open-source a working (profitable) trading bot.” This is to say that no one would realistically create profitable algorithms for free. It is incredibly tough to outperform the financial markets as they’re unpredictable by nature. If someone learned of mispricing, everyone would quickly flock to take advantage of it, and the mispricing would vanish in the blink of an eye. As a result, people tend to experience more losses than profits. 

Paid platforms hold a similar reputation in that only a small percentage of bot creators actually make the effort to align their interests with those of their investors. This is usually an early warning sign that the platform’s bots were never intended to be profitable to begin with. This is unfortunate for retail investors who tend to lose a lot of their money this way, but who also don’t have many other options. Legally, some brokers are required to disclose what percentage of their clients lose money, and in many cases, it is above 70%. Make sure to consider these figures when deciding whether to use a bot. 

Next, building your own trading bot. This option has seen an increased popularity over the last couple of years. Although with some platforms it’s quite easy to set up a trading bot, success (profitability) is determined by the user’s trading skills and their experience trading the markets. The reason for this lies in the fact that to build the bot, you have to set the trading execution criteria which will be based on the user’s personal decision-making process when trading manually. 

Lastly, we have quant funds. In regard to quant fund bots, performance results vary depending on the basis upon which an algorithmic trading strategy is built. In 2018, for example, when the S&P500 index was 19.42% high, an algorithmic trading fund called SH capital partners had a 234.09% return. Meanwhile, Silver8 Partners and Global Advisors Bitcoin Investment Fund returned 770.75% and 330.08%, respectively. Both instances of algorithmic trading were automated. While each used different tactics, they all credit their successes to their automatic trading strategies. 

A well-acknowledged benefit of quantitative trading is also risk diversification. At any given time, algorithmic trading allows traders to diversify their portfolios across many accounts, methods, or marketplaces. Diversification spreads the risk of various market instruments while also protecting them from losing positions. Quant trading reduces the operational costs of conducting large quantities of trades in a short period of time by automating trading. 

It’s important to remember that even the most successful algorithms, with moderate levels of volatility (e.g., a Sharpe ratio of 2+ and maximum drawdowns of 5–10%) have a finite shelf life since any algorithm that consistently outperforms the market will experience alpha decay (the decrease in value due to others getting in on the action).   

So, are trading bots profitable?

The quick answer to the question is that they can be profitable if you understand and follow these key principles: 

1. Avoid the market place risks described above. 

2. Understand that market conditions are a crucial factor in the efficacy of the trading bot. There should be a presence of ongoing monitoring to encourage constant improvement. Remember, profitability is a moving target and bot trading is not a ‘set it and forget it’ activity. It involves multiple tests of multiple bots under different market conditions and making the necessary adjustments accordingly. 

3. You need to understand that it’s not simple and easy but it’s an ongoing process that requires the involvement of professionals (in case you build it on your own). 

In the case that you invest with a quant fund that trades based on AI and Robo-advisors, have in mind that such firms are able to use much more advanced, tailored technology. This could increase your chances of achieving higher risk-adjusted returns. As a firm invested heavily in developing our own trading bot technology, we understand through experience the reality behind the process of building a working, profitable bot.  

If you are interested in investing in ready-made portfolios developed using trading bots and AI, we welcome you to open a free account with arty.  

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