This post was most recently updated on April 23rd, 2020
A trading bot, also known as a trading robot, is software that follows an investment strategy in the financial markets. There are many dedicated to Bitcoin and crypto and they are surrounded by many myths.
How do crypto trading bots work?
To understand how a trading bot works, you have to understand what a trader does on a daily basis. First of all, a trader designs his crypto trading strategy. It notably defines entry and exit points, risk criteria, etc. This is not the subject, so I will not dwell on it. Then he must apply this investment strategy. By simplifying somewhat, he analyzes the current situation, checks if this situation implies an action in his strategy, then, if necessary, performs this action. For a trading bot, the same steps are required, they are simply adapted for software!
First, to analyze the current situation, the trading bot retrieves market data. Second, it checks whether the current situation calls for action in the investment strategy. To do this, he must be able to understand this investment strategy, for example by calculating variations, indicators, etc. Finally, if the current situation involves action, for example, “Buy 1 bitcoin”, he sends the order to the exchange platform thanks to its API. Most exchange platforms offer APIs. These are access points that allow any software to connect to these platforms. It is thanks to these APIs that a bot can act on your account on an exchange platform.
What are the advantages and disadvantages?
The advantages seem at first sight numerous, especially with such volatile markets. We can save time since there is no longer any need to analyze the markets continuously. We can increase its efficiency since a bot does not give in to its emotions (it is software after all…). No more FOMO (Fear of Missing Out), no more panic when prices are moving, the bot simply applies the investment strategy.
One can thus imagine for Bitcoin bots which would apply a strategy of Dollar-Cost Averaging (DCA). When you want to invest in an asset, the DCA consists in buying this asset for a defined amount at regular intervals. The aim is to reduce the risks associated with volatility and psychological pressure. In this example, a bot saves time (no need to log in each month on its exchange platform to place the purchase order) and efficiency (we do not ask questions such as ” the course is high enough at the moment, I will wait for it to drop before placing the purchase order ( which are contrary to DCA ).
But behind these advantages are also drawbacks. The bots bring in particular additional costs which decrease your profitability. They are also an additional intermediary with your trading platform, reducing the security of your funds on these platforms.
Finally, remember that trading bots do not replace the most important part: designing the investment strategy. It is generally up to you to program this investment strategy, whether via a visual interface or lines of code. Knowledge of trading is essential. Some crypto trading bot platforms offer to copy or rent strategies designed by other traders. In this case, knowledge of trading is also essential to select strategies. The selection criteria are essential and the monitoring of your bots remains important because no strategy will be successful in all situations.
Trading bots are not a quick fix. They have certain advantages but remain only tools at the service of traders.
Some tips to avoid mistakes and abuse
Finally, here are some tips to avoid mistakes and abuse:
- Train yourself! It is essential to understand what trading is to properly use bots. Many free online resources exist, take advantage of them.
- Test your bots. Most bot platforms offer simulation systems that allow you to safely test your bots. Keep in mind, however, that past results do not guarantee future results.
- Watch out for scams! In general, run away from bots that are too attractive and promises that are too good to be true.
- When you connect your trading platform to a trading bot, you can usually specify the rights that the bot will have on your account on the trading platform. Only grant minimum rights, especially not the right to withdraw your funds. In general with Bitcoin and cryptocurrencies, remember that “Not your keys, not your coins“. Keep only what you want to trade on an exchange platform.
Here it is an article that reviews some crypto trading bots: How to Make Money with Bitcoin: Top 10 Ways to Earn Bitcoin.
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