Time waits for no one and financial markets are no different, especially when it comes to the unpredictable world of cryptocurrency trading, which is why a carefully calibrated, safe and reliable trading strategy is essential. Unlike traditional stock markets, cryptocurrency trading never stops, making it virtually impossible for private traders to track market fluctuations, diversify risk, reduce error and ensure trading discipline 24 hours a day, 7 days a week, 365 days a year.
Unless, of course, you have some help, which is where automated crypto trading bots come into play.
What is a crypto trading bot?
A bot is simply an automated program that operates on the Internet and performs repetitive tasks more efficiently than humans. In fact, some estimates suggest that around half of internet traffic is made up of bots that interact with web pages and users, scan for content, and perform other tasks.
Cryptocurrency trading bots operate under the same basic principle. They’re software programs that execute functions using artificial intelligence based on pre-established parameters. No more missed trades or missed opportunities - by running a set of algorithms, you can automatically buy, sell or hold assets in a timely, efficient and automated manner day or night from anywhere in the world.
Crypto bots come in many shapes and sizes, but they all fall under four main categories: trend-trading bots, arbitrage bots, coin-lending bots and market-making bots.
As their name suggests, trend-trading bots attempt to capture gains through the analysis of an asset's momentum in a particular direction track. Discerning trends can be useful when implementing take-profit or stop-loss provisions in order to capture profits or prevent losses.
Arbitrage bots are used to identify inefficiencies and price differences across markets.
For those interested in lending cryptocurrencies at advantageous interest rates with limited risks, coin-lending bots automate the process, mitigating volatile interest rates and loan repayments by borrowers.
And market-making bots turn a profit on the difference between the ask (selling price) and the bid (buying price), which is called the spread.
How do trading bots actually work?
By communicating directly with crypto exchanges and placing orders automatically based on your own preset conditions, crypto trading bots offer exceptional speed and efficiency, fewer errors and emotionless trading. In order to trade on an exchange, you must authorize a trading bot to access your account via API keys (Application Program Interface), and access can be granted or withdrawn at any time.
Trading bots work in three essential stages: signal generator, risk allocation and execution.
The signal generator essentially does the work of the trader, making predictions and identifying possible trades based on market data and technical analysis indicators.
As the phrase implies, risk allocation is where the bot distributes risk according to a specific set of parameters and rules set by the trader, which typically includes how and to what extent capital is allocated when trading.
It’s go time. Execution is the stage in which cryptocurrencies are actually bought and sold based on the signals generated by the pre-configured trading system. In this stage, the signals will be converted into API key requests that the crypto exchange can understand and process.
What are the advantages of using a trading bot?
Why should you care about automated trading bots? Two words: Wall Street. Many reports suggest that 80% of trading on the stock market is done via algorithmic-based automated programs. Comparatively few private traders, however, make use of algorithmic trading, partially due to the perceived complexity and costs.
You’ll often read that more than 80% of private traders lose money due to a variety of factors. Trading volatile cryptocurrencies is emotional work and with emotions come errors in judgement. As much as 39% of manual trades are influenced by our emotional states, which can cause us to make irrational decisions. It’s simple human psychology.
Choose instead to be among the 20% of smart traders who make money by harnessing the power of trading bots to ensure a non-emotional, systematic approach to trading.
Higher trading speed
Time is money. And when it comes to speed, bots are simply faster: millions of computations and thousands of transactions across various time zones and markets almost instantaneously. Trades happen in a fraction of second – far faster than anything an individual trader can accomplish, which is one reason Wall Street has been using algorithmic trading for decades.
In the time it takes you to read this sentence, a trading bot could have made multiple profitable trades for you.
Back testing and paper trading
Pilots learn to fly with flight simulators, and traders should be using market simulators when learning to trade for the exact same reasons. We learn by doing, but we don’t want to lose money (or crash an expensive plane) in the process. Even experienced traders can reap the benefits of trading simulators.
With trading bots, backtesting and paper trading allow you to harness the power of historical data to simulate the viability of a particular trading strategy or pricing model. The point is not to predict the future (after all, we’d all be rich by now), but to determine how well (or poorly) a particular trading strategy is likely to perform based on historical data. Armed with a reliable backtesting tool and an accurate set of data, you can explore new strategies, add expertise and build confidence before you’re ready to put your money on the line.
If you’re looking for a get-rich scheme, then you’re better off heading to Vegas.
Trading bots are about minimizing risk by not putting all of your eggs in one basket. We all know that cryptocurrency markets can be highly volatile, which is why a prudent trading strategy should include risk diversification. One way to diversify your risk is to run multiple trading bots. And while a diversified portfolio is certainly not foolproof, it can balance risk and reward in order to reduce exposure to any one particular asset. Age-old advice that still rings true with cutting-edge technology like trading bots.
Consistent trading discipline
Learning a language, finishing a marathon, becoming a Zen master. They all require one thing: discipline. And trading is no different.
But discipline is difficult (how many Zen masters do you know?). By automating the trading process, however, bots ensure consistent trading discipline even in volatile markets when fear can lead you to sell or luck can cause you to buy. Because of pre-established trading rules, bots optimize long-term performance without the short-term costs of emotional human interventions.