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What is a crypto trading bot? Everything you need to know

Bitcoin
(Image credit: Shutterstock / REDPIXEL.PL)

With cryptocurrencies taking the financial world by storm, both institutional and retail investors are exploring the additional value returned by applying advanced technology to their trading strategy.

While learning to trade every type of asset has become mainstream in recent years, thanks to the broad availability of online learning tools, time and resources continue to be scarce for self-learners and traders of all backgrounds.

This is where technology, in the form of a trading bot comes to the rescue, saving time and making trading much more efficient. In the crypto world especially, a trading bot can remove the trouble of portfolio construction as well as the need to devise, execute and maintain a trading strategy in this fast-paced, often volatile market.

Trading bots are not new. They were first established in Forex trading in the early 2000s, but the concept of automated trading goes as far back as the 1950s when Richard Donchian introduced a set of rules to buy and sell funds. Automated trading systems like bots now manage huge volumes of assets all around the globe with roughly 75-80 percent of all stocks being traded via bots. More recently, as institutional financial companies have entered the crypto markets, they have bought these trading bots with them, which have been adapted and applied to cryptocurrencies, and we’re now starting to see bots made available for retail participants too.

About the author

Anton Altement is CEO of Polybius and OSOM Finance

What exactly is a crypto trading bot anyway?

Cryptocurrency trading bots are basically software programs that often leverage artificial intelligence and machine learning to observe the market and automatically execute cryptocurrency trades in line with predefined algorithms.

Ideally, the bot generates a profit, and that profit is greater in risk-adjusted terms than if you had simply just bought the same coins and held them throughout.

Although you’d think high returns is the ultimate goal, what you really want is high risk-adjusted returns, and this is the true potential for a crypto trading bot.

Fundamentally, if it can capture most of the upside of cryptocurrencies with risk-reduced exposure to the drawdowns, all managed autonomously - this should make a much more attractive proposition than simply having a passive buy-and-hold strategy.

Why use a bot?

There are two main use-cases for trading bots. Firstly, bots can make the whole process a lot simpler and streamlined. They can take care of factors such as portfolio diversification, index construction, portfolio rebalancing, etc. But automation doesn’t mean it's completely hands-off. You still need to take care of the basics and do your due diligence on which cryptocurrencies are being selected by the bot etc.

The second use-case is more complicated and advanced, where bots are used as part of an active day trading strategy, automating components that are time-consuming, pretty repetitive and may involve unnecessary complications. In this case, traders use bots to overcome;

  • Repetitive tasks; like conducting hourly rebalances.
  • Timing trades; achieving a high degree of accuracy in your trading is extremely necessary, a bot can be easily programmed to monitor the market and execute a trade at the correct times.
  • Automating strategies; the crypto market is open 24x7 and is highly volatile, the price can change around the clock and a trading bot can help execute your strategies whilst you sleep.

Fully-automated crypto trading bots

If you’re dipping your toes into the crypto market, a fully-automatic trading bot grants crypto enthusiasts (and experienced traders too) exposure to the entirety of the crypto market without any of the difficulty.

With 6,000+ cryptocurrencies on the market, appropriate diversification and subsequent asset management can be an extremely time-consuming undertaking, particularly with the rise of the DeFi sector. Instead a fully-automatic trading bot can provide the necessary portfolio diversification while controlling the downside, via a tried and tested trading strategy. 

The necessary research and due diligence is done on your behalf though by humans rather than bots (yet!). Teams of researchers manually assess the fundamental factors such as the asset's team, roadmap and use case to determine potential gains as well as project legitimacy and longevity.

Once satisfied with the legitimacy of the project, the bot takes over as a cryptoasset is included in its universe of tradable assets.. From this point onwards, the bot is continuously tracking the token’s technical data such as its trading history, volume, and liquidity.

As long as the technical data remains within acceptable range, the bot trades the asset according to its preset trading strategy, all with the aim to avoid price drawdowns and generate optimum returns.

The algorithm also leans on machine learning to evolve it's trading strategy, studying market timing and determining the best time to buy or sell. Which also removes the cognitive biases that often creep in when executing your own DIY strategy.

What to look out for when picking a trading bot

  • What is the experience level of the team who have developed the trading bot? Look for attributes that point to a reputable team, things like companies the members have previously worked for, how long they have been working and testing the bot, reputation of members on their advisory board, the technical ability of the founding team etc.  Have they managed $100m+ and have a good track record doing so?
  • Transparency; are their algorithms widely known and openly available to anyone? Has the team been transparent about the results of their trading strategy, implementation, backtesting, etc.
  • Trading strategy, how do they select tokens for the bot, are there tokens you don’t want exposure too, like privacy coins or stablecoins? What is their process for vetting tokens? 
  • Is their success aligned with your success? If you make money will they succeed too? 

With trading bots becoming a hot topic for millions of users around the world, even with the coronavirus pandemic continuing to throttle global economies, the market for robo advisors has only grown further, with usage increasing between 50% and 300% in the first quarter of 2020 from the quarter prior. With JPMorgan also revealing their plans to roll out its own robo-advisor next year, maybe it’s time for you to see if a trading bot can help automate your strategy and outperform the market?