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What is the Pros and Cons of Automated Trading Systems?

Auto-Trading - Definition

A service offered by some brokers where trading recommendations made by third party advisors are automatically executed by the broker on behalf of the account holder.

Options Auto-Trading - Introduction

Options Auto-Trading, also known as autotrading, has been gaining both popularity and controversiality in the options trading world.

Auto-trading is having your broker automatically execute trade recommendations issued by options pick services that you subscribed to. When auto-trading is used in conjunction with a reliable and consistent options pick provider, your account will automatically grow with little or no involvement on your part at all. This is why more and more traders are asking for and joining auto-traded services. However, auto-trading is not all good and no bad. There are serious flaws with such an arrangement that makes auto-trading potentially dangerous.

This tutorial explores how auto-trading in options trading works, its advantages as well as its disadvantages.

What Exactly Is Options Auto-Trading?

Auto-trading is a service that is not limited only to options trading. There are auto-trading services for stock trading and futures trading as well. However, auto-trading for options has really picked up momentum over the past few years with more and more options signals providers approved and accepted for auto-trading by major options brokers.

Auto-trading is a three way agreement between an options broker, an options trading account holder and a third party options trade advisory service provider that takes the form of a Power of Attorney (PoA) granted to your broker for placing trades recommended by third party trade advisory service providers on your behalf and an indemnity to indemnify the broker from any losses that may occur. Options brokers usually offer such a service for no additional charge beyond the normal commissions charged on each trade. The broker profits from the commissions, the trade advisor profits from your subscription fees and you profit (or loses) from the trades made by these recommendations.

The broker then proceeds to open and close options trades in your account based on the recommendations by the third party service providers that you are signed up with. This happens directly, automatically, between your broker and the options trade advisory service providers without your involvement nor consent after the agreements are in place. This means that your further permission will not be sought by the broker when placing such trades even though you would usually receive an email notification from your broker when such options trading activities take place.

Not all third party options picks service providers are approved for auto-trading by every broker. In order to enter into an options auto-trading arrangement, you need to sign up with a third party options advisory service provider that is approved by your specific broker.

Options Auto-trading Process

Advantages of Options Auto-Trading

The only advantage of auto-trading is the complete removal of human emotions. Options, as a leveraged instrument, can trigger dramatic emotional responses, due to volatility, from options beginners which leads to costly trading mistakes. This is why options auto-trading is immensely popular amongst options trading beginners who, through their initial losses, understand the value of not involving their own emotions in trades.

The result of options auto-trading subscribed to a consistently profitable options picks service provider is watching your options account grow quickly and consistently without any involvement on your part as long as you stay subscribed to the service.

Disadvantages of Options Auto-Trading

The main disadvantage and risk of auto-trading is exactly the removal of human emotions and why options veterans rarely use auto-trading arrangements even if they are convinced of the accuracy of the options picks service providers they are subscribed to.

The problem with auto-trading is that a standard trade management, stop loss and profit taking policy is used across the board without regards to the investment objective and fund size of the account holder. All veteran investors and traders have investment objectives and such objectives may require customized stop loss and profit taking policies in order to attain quickly and reliably. Such needs may not be well served by a standardized, one size fits all, approach.

Most importantly, using a standard, percentage based, trade management policy on all accounts have different bearings on small and big account sizes. For big account sizes trading aggressive "win all or lose it all" type of picks, the value at risk is significantly higher than the same percentage policy used on small account sizes, resulting in unexpectedly high losses. This makes risk management for your account almost impossible. Liquidity also becomes a concern if extremely huge account sizes are made to enter a significant position on a less liquid options contract, resulting in difficulty in profit taking or stop loss.

Auto-trading aggressive short term trading advise that makes multiple trades over very short time periods with a very small account size also results in extremely high commissions build up which in some cases can completely obliterate any possible profits.

Also, having trades made in your account automatically without even looking at them also expose you to the risk of obviously bad trades recommended by your service provider by accident or intent. You should always be the final goalkeeper of your money. Leaving your account absolutely to the wimps and wills of a third party without even monitoring the trades can be extremely risky.

Read the SEC Risk Disclosure on Autotrading

Options Auto-Trading Conclusion

While automated trading is becoming more and more popular, auto-trading on leveraged instruments such as options does carry with it risks that cannot be ignored. As such, options auto-trading cannot be looked upon as the holy grail of money making and shouldn't be left completely on its own accord even if you decide to sign up for such an arrangement in your options trading career.

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