Cryptocurrency trading bots are programs that rely on different indicators to interpret trends and execute trades. Algorithms have been used in trading software in commodity, currency and equity markets by investors to hedge funds. Only recently has it become common practice to use such algorithms to handle crypto assets.
The cryptocurrency market is different from the stock market. It never closes and the scenario is always emotive for the trader. Users are familiar with the random highs and lows they see in their portfolio. Since the cryptocurrency market is volatile, bots help the trader to retain control over their trading times. The bot will not go to sleep when you do.
Additionally, bots can execute trades faster than you would. If the specifications and factors to consider are input correctly, the bot will improve efficiency. There are currently many trading bots on the market ranging from free software to subscription-based offers for professional day traders. The different trading bots will vary in profitability, quality, and usability.
How trading bots work
Essentially, a cryptocurrency bot is a program that relies on APIs to get and interpret information from financial exchanges. Based on the find outs, the program sells or buys orders on your behalf. To make decisions, bots have to monitor the price movements in the market and react appropriately based on rules and factors that you pre-program.
Most bots will look at marketing actions like orders, volume, time and price. The ideal cryptocurrency bot for you must account for your preferences and tastes. Bots use an exponential moving average (EMA) as the starting point to look at a market. The trader sets a threshold corresponding with their appetite for risk. A downside of EMA is that history may not always predict the future accurately especially in the volatile cryptocurrency industry. One could end up automating a poor trading decision.
Note that for a long time, crypto bots were not available because they meant huge investments for the user. The transparent nature of cryptocurrency exchanges and the blockchain has made it that some exchanges allow you direct market access, allowing you to analyze the electronic order books of the exchange, a right that was not available to traders in traditional financial markets.
There are also many people who prefer to trade passively. If you are unable to dedicate time to do complete market analysis, consider using bots that do not require you to keep abreast of market trends all the time.
Common bot strategies
The cryptocurrency market is still young compared to other financial markets. Even so, the use of technology in trading has caught on fast as investors enjoy a wide range of competing services. Most bots will use the following strategies:
When crypto trading was new, traders used arbitrage as a primary strategy. In this case, you buy an asset on one market and then sell it in another at a higher price to make a profit. When exchanges became decentralized, the differentials between the buying and selling prices became higher and so traders had to make a profit through arbitrage.
The differentials between the exchanges have reduced now, but they show up once in a while. Trading bots help the user to make money off these exchange spreads. What is more, traders can use arbitrage to take advantage of futures contracts. They benefit from any spreads between the contracts and the underlying assets.
In this case, the bot allows the investor to buy and sell continuously at different prices to try and find any spread between the buying and selling price. The buy and sell limit orders have to be close to the existing market. That way, when prices change, the bot keeps placing limit orders and earning you profits off the spread. If one is working in low liquidity environments, this strategy could prove unprofitable.
Consider the following things when choosing a trading bot:
Consider how reliable the bot you want to use is. You cannot afford to lose opportunities because an algorithm keeps malfunctioning. Check to see user reviews before adopting one.
You cannot lay blame on anyone in case of a hack. You give the bot access to your funds once you start trading, so consider what security features a bot offers.
An effective bot must be able to leverage trading expertise to earn you profits.
Pick a network with no room for foul play. It is better if the developers are well known.
Risks of trading with bots
Every time you give money to a third party, whether it is trading software or a fund manager, there is a risk involved. In cryptocurrency trading, the risks are higher because the market is illiquid and immature. Besides those, other risks include:
- Faulty software – All trading bots are not the same. A poorly coded algorithm could cost you money.
- Flash crashes – In 2017, ETH crashed on GDAX and led to heavy losses in less than a minute. Users without set stop limits lose more in case of a flash crash.
- Scams – Trading bots could also turn out to be scams like has been the case with forex bots. In 2017, some investors lost assets due to Hexabot when the algorithm halted withdrawals from the platforms before shutting down with investors’ assets.
A cryptocurrency bot will allow you numerous benefits. However, be keen to use the bot as a tool. Bots are not intended to become passive income generators. Many of those, which promise no work on your end turn out to be scams.
Sophisticated trading bots will allow you to set your trading parameters before executing trades on your behalf. Be sure to backtest the parameters with time. The crypto space is growing and daily evolving. You will need to adjust your strategies to function well in different market conditions.