What Are Crypto Trading Bots?
Crypto trading bots are just what they sound like: programmable, virtual robots (bots) that make automatic trades. A human trader can program a trading bot to follow certain rules and execute particular trading strategies. A bot can either send signals to its user or execute trades automatically as market conditions change.
This type of trading is also sometimes referred to as “high-frequency trading” or “algo trading” because it allows for many trades to be placed quickly and relies on computer algorithms to follow pre-set rules. In the United States, the share of high-frequency trading in equity markets is estimated to be 50%. While similar data hasn’t yet been collected on crypto markets, a significant portion of the trading activity on most cryptocurrency exchanges may also happen at the hands of bots.
Understanding Crypto Trading Bots
Trading cryptocurrency, or any asset for that matter, can be a lucrative but difficult task. So investors looking to build a well-balanced crypto portfolio might choose to use all available tools, including bots, to gain every advantage when trading crypto.
Timing the market is not easy to do. The vast majority of actively managed investment funds in the world of traditional finance (TradFi) never outperform the major benchmark indexes. It’s not unreasonable to assume that the same might be true for crypto markets when it comes to hedge funds or retail traders.
One of the many reasons that individual investors and institutional investors can fail to beat the market in the near term might have something to do with a preference for trading bots’ hard-to-beat alacrity. Bots can make decisions, and act on them, in milliseconds!
A crypto bot can accomplish this either by
• Sending trade signals to the user, or
• Executing buy or sell orders automatically.
In the first instance, users would be notified the moment certain market conditions are met, at which time they could execute a trade manually. This might be a simpler version of a crypto trading bot.
What most traders want from a trading bot is the second option: They’re seeking a bot that can do more than send real-time signals to a human trader — one that can track things like price movement, trading volume, demand, buying or selling pressure, and other technical indicators. Bots can execute many trades in a fraction of time it would take a human to place a single buy or sell order.
Crypto trading bots are designed to be used by traders to act on market changes the moment they happen, instead of after the fact. Human traders often must wait for a trigger to occur in the market before they trade, or they use simple stop-loss or stop-limit orders to try to hedge tier risk. Bots, on the other hand, can be programmed to wait for specific signals, then trade accordingly. Bots can trade more strategically and rapidly than a human — with human input.
How Do Crypto Trading Bots Work?
A crypto trading bot can execute trades automatically by interacting directly with a cryptocurrency exchange; placing buy or sell orders when certain predetermined conditions are met. Essentially, bots use technical indicators — which are based on mathematics relative to price movements — to make decisions.
In terms of the user interface, trading bots operate in various ways: Some come with an internet browser plug-in that allows the trader to interact with the bot. Others have standard operating-system clients that come as downloadable apps. And some are in the form of software designed for cryptocurrency exchanges.
Trading strategies involve multiple methods:
• One common method relies primarily on exponential moving averages (EMA). A bot might be programmed to place particular trades when this indicator moves beyond a certain point.
• Some bots use variants of the approach, such as double or triple EMAs. A moving average is derived from the average of price movements over a set time — such as a nine or fifty days, for example.
• As a tool for making investment decisions, a double EMA combines data from two moving averages; a triple EMA uses data from three moving averages, and so on.
• There are crypto trading bots that use other automatic indicators, such as the relative-strength index, and certain regression-analysis techniques.
Other Types of Bots
The bots we’ve discussed so far work on a single crypto exchange. Yet, bots can employ other technical trading techniques, such as charting and “inter-exchange arbitrage.”
Bots For Arbitrage
Crypto arbitrage involves taking advantage of the price differences of a single asset across different trading platforms. If bitcoin or another cryptocurrency is trading at $10,000 on one exchange and at $9,950 on another, an arbitrage bot could buy the asset on the exchange where it’s cheaper and sell it on the one where the price is higher.
Bots For Technical Charting
Some traders use technical charting to map out their trading strategies. Charting can take a long time, even for the most experienced trader. A bot, on the other hand, can be programmed to look at the charts’ metrics and act almost instantaneously.
Are Trading Bots Legal?
Automated trading is a well-known and legal activity across most financial markets. Half of stock market trades in America are automated, and the process is 100% legal.
Likewise, in most countries and on most cryptocurrency exchanges, there are no laws that prohibit using crypto trading bots. That said, cryptocurrency rules and regulations are in flux, so it can be helpful for investors to familiarize themselves with current crypto trading rules before diving into automated trading.
Is Automated Trading Profitable?
A crypto trading bot may be profitable when used carefully and under the right circumstances. When placing large volumes of orders over a short time span, it is possible to rack up profits by squeezing out small gains on each trade. Of course, losses could mount quickly as well.
Crypto Bots Need To Be Managed
Using a crypto trading bot doesn’t work in a “set it and forget it” fashion. First, it’s important to develop a trading strategy. And once you’ve outlined a strategy, it’s critical to monitor the results you’re getting; you may want to adjust your strategy. Moreover, markets do not trade on technical analysis alone. In fact, it’s equally essential to apply fundamental analysis when trading any asset. Fundamentals are generally easier to understand and apply for many investors.
Emotions Can Color Trading Decisions
Perhaps one of the greatest benefits of a crypto trading bot is that it takes the emotion out of trading. Greed and fear can harm a portfolio and even the economy. When the market is going up, investors can become greedy. If a trader’s avarice makes them trade fast and furiously, they could miss changes in market conditions until it’s too late to take a profit.
When financial markets go down, investors tend to get fearful. A trader could make a bad decision while in a state of panic, like selling at the bottom of a downtrend.
Finally, bots are capable of recognizing fundamental market forces like big news headlines, events, or rumors — such as when PayPal (PYPL) announced it would allow users to buy and sell crypto on its platform. Nor can they sense macroeconomic trends like a rise in the price of lumber for housing starts, or how an oil spill might affect petroleum exports.
How to Choose a Crypto Trading Bot
Here are some factors that investors would want to consider carefully when choosing a crypto trading bot:
• How complex is the bot? It’s important to ensure that you can understand and utilize the bot’s technology successfully.
• What strategies does the bot use? For investors with a specific preference — such as arbitrage, for example — this matters.
• If you’re just starting out trading crypto, or are new to trading with bots, it might make sense to use a bot that comes programmed with existing strategies.
• Look for fees to be stated clearly and up front, with no hidden costs.
• Do your due diligence on the team that develops a particular bot? Do they display their contact information, offer a support team, and provide a profile on their website?
• Word of mouth counts. What do others have to say about the platform?
Trading bots are one way to begin investing in cryptocurrency. A bot can send signals to its user or execute trades automatically, and lightning fast. And a crypto trading bot can take the emotion out of trading in cryptocurrencies — which usually have a higher degree of risk than traditional investments.
The SoFi Invest® investment platform provides all the tools needed for novice and experienced investors alike.
Third-Party Brand Mentions: No brands or products mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A., or SoFi Lending Corp.
Photo credit: iStock/CasPhotography