Algorithmic trading might sound very technical – and it is. But our mission at HAL (formerly Napbots) is to make algorithmic crypto trading available to all, regardless of proficiency in finance. In this article, we will provide a simple definition of trading, walk you through different types of automated trading, and give a recap of advantages and disadvantages of this approach to trading.
Trading 101: What Is Trading All About?
To understand algorithmic trading, you must first be familiar with trading. Trading means actively buying or selling an asset. There are many assets available on the market, and you may have heard of stocks, bonds, or… cryptocurrency. HAL is exclusively dedicated to crypto, so this is the example we will use.
When you trade, you take a financial position on the price direction of related assets.
Let’s break this sentence down. Taking a position is a financial term to indicate you are buying (long position) or selling (short position). Price direction of assets is the rise or fall in value you are expecting them to reach in relation to each other.
So what are these related assets? In crypto markets, you can trade on individual cryptocurrencies against the US dollar (in crypto/US dollar pairs) or against another cryptocurrency, via crypto/crypto pairs.
It will become even clearer with a couple of examples. Trading is about making decisions, based on market analysis and time frames. If you believe the value of BTC (bitcoin or BTC is the primary asset of the Bitcoin blockchain) will rise against the US dollar, you go long – which means you buy BTC using US dollars. On the contrary, if you think the value of ETH (ETH is the primary asset of Ethereum) will fall in relation to bitcoin price, you go short on ETH/BTC – you sell it.
In finance, margin trading is the practice of borrowing funds from a third party to increase your leverage. This is also possible in crypto, and it allows traders to have an overexposure, or leverage, to the underlying market with a small deposit. But remember, crypto is highly volatile, making leverage trading very risky.
One last bit of vocabulary: when prices go up for a certain period of time (weeks/months), we say we are in a “bull” period (or bull market). On the contrary, a “bear” period happens when prices are falling.
Using Bots to Perform Algorithmic Crypto Trading
Algorithmic crypto trading is also sometimes called automated crypto trading. As both names imply, it relies on algorithms to make automatic trading decisions. These algorithms are bots (short for robots): they are programs that can interact with other users and systems on the web, autonomously.
Suppose you have set up a bot on your exchange to trade on bitcoin. This bot is built to follow a specific set of rules. One of these rules could be: “sell bitcoin when the price falls below $30,000”. The bot continuously scans the market, and when the value of bitcoin falls below the specified threshold, it automatically goes neutral or short. You don’t need to be logged in to the exchange to perform the action. The bot does it for you 24/7.
Of course, this is a very basic example. Most bots are trained on massive amounts of market data to try and predict future states in the market. Thanks to machine learning, they analyze the market with much more precision and make complex decisions. Instead of selling based on a single number as in the example above, the rule could then be: “go neutral when bitcoin prices fall below daily moving average for the past 50 weeks.”
2 Different Types of Algorithmic Crypto Trading
There are many ways to trade. Each trader might have their own favorite strategy, or combine a few. Here are two examples of algorithmic crypto trading strategies we use at HAL.
1) Trend following
This strategy moves in line with the market. According to this approach, you should buy an asset when its price goes up and sell it when it goes down. Why is that? Because you are expecting price movements to continue in the same direction.
💡 When to apply it?
When there is a clear trend on the market, for example in the December 2020 – March 2021 bull trend on bitcoin.
2) AI Meta
AI Meta strategies leverage artificial intelligence to make buy/sell decisions. They automatically choose among the different strategies available at a given time, based on predictions for the short-term future.
💡 When to apply it?
As this is a short-term strategy, it strives to adapt itself to the state of the market at any given time. As a result, it is not linked to a specific market trend (bull or bear).
Advantages and Disadvantages of Algorithmic Crypto Trading
Algorithmic strategies follow rigorous and coded rules, which have been built after backtesting. Backtesting is running a strategy on past market data to see how well it would have performed. Still, remember that past performance is not a good indicator for future results.
Automated crypto trading frees up time. You do not have to make decisions based on your intuitions or feelings on a given day. You do not even have to be online for the strategies to be operating.
However, algorithmic crypto trading also comes with disadvantages. No strategy is 100% foolproof. There can be false signals as the market evolves, leading to mistaken decisions.
You also need to take trading fees into account, as exchanges charge a fee for each transaction. It may seem small at first, but if your strategy involves a lot of trading (called ‘turnover’), it can make a serious dent in your profit. Want to give algorithmic crypto trading a try? HAL is a great place to start. It only takes a few minutes to set up an account, connect it to your exchange, and benefit from expert strategies.
Investing involves risk, including the possible loss of all the money you invest. In particular, crypto-assets are a highly volatile and speculative asset class. HAL is only suitable for traders who are willing to bear the risk of loss and experience sharp drawdowns. Past performance is not necessarily a guide to future performance.
The purpose of this material is to provide objective, educational and interesting commentary and analysis on developments in the crypto-assets sector. Nothing in this material should be interpreted as constituting an offer of (or any solicitation in connection with) any investment products or services by any member of the CoinShares Group where it may be illegal to do so. Access to any investment products or services of the CoinShares Group is in all cases subject to the applicable laws and regulations relating thereto.