Emotions vs. calculations: What are the benefits of rule based trading?

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In the previous chapter, you were introduced to the concept of a rules based trading system and what it entails. Now that you’re aware of this concept, it is time we explored the various benefits of trading using a rule based system.

Did you know that many expert and professional traders use rules based trading systems quite extensively? Yes, that’s right. And there are plenty of reasons why they choose to do so. All of that is what we’re going to be looking at in this chapter of Smart Money. Let’s begin.

Benefits of rules based trading systems

Of late, an increasing number of investors are turning towards rule based trading as a means to make money from the stock market. The advantages that such a system offers are aplenty. Here’s a quick look at a few of the benefits of trading with a rule based system that you get to enjoy.

1. They’re systematic and not arbitrary

Rules based trading systems are very systematic since all of the trading decisions that it takes are defined through sets of rules and conditions. This is quite unlike a discretionary trading system, where it is up to the trader to decide upon a trading decision.

For instance, with a rule based trading system, the decision to buy a stock is entirely dependent on whether the stock and its price movements satisfy the rules and conditions set by the trader. The stock is either bought or sold only if it satisfies the user defined criteria.

2. They can be customized according to your requirements

A major investment benefit that you get to enjoy through the use of such a trading system is customizability. A rules based trading system is versatile and can be easily tweaked according to your investment strategies, goals, and requirements.

For instance, let’s say that you wish to employ an investment strategy designed for range bound stocks that are trading within their support and resistance levels. You can customize your rule based trading system to buy a stock when it touches its support levels and sell it when it touches its resistance.

And if you wish to change your investment strategy or goal midway, all that you would need to do is tweak the rules of the system accordingly and re-deploy it.

 

3. They disregard emotions completely

As you know already, human beings are emotional creatures. And as a result, we tend to harbour several biases. At times, we can even let our emotions get the better of us, which can end up derailing our investment strategy completely. Despite having a clear cut investment plan, we may sometimes find ourselves questioning the trade subconsciously.

However, this is not possible with a rules based trading system. Since every single trade is automated and happens only when the set criteria is met, there’s absolutely no chance of emotions creeping in. By keeping the emotions at bay, the system allows you to stick to your investment strategy.

4. They can be extensively tested before being deployed

Another one of the benefits of trading using a rule based system is the fact that the system can be backtested before actually being put to use. This, however, is not possible in cases where the trader is manually responsible for making all the trading decisions.

For instance, let’s say that your rules based trading system is designed to place a buy order when the price of a stock crosses its 200 DMA. Now, before actually deploying it in the real world, you can test its performance against historical price action data for that stock. This allows you to gauge the trading system’s performance in a much better manner.

That’s not all. It also gives you the chance to iron out any chinks in the system and account for other wild discrepancies as well.

5. They can enhance trading speeds

When you trade normally, everything from the trading decision to the order placement has to be manually carried out. And no matter how fast you may be, it takes around a minute to carry out a trade. Although it might seem like not too long of a delay, when you’re trying to execute multiple trades in quick succession, every second is key.

Here’s where a rules based trading system has a distinct advantage. Since all your trading activities are automated, the speed at which you place orders tends to be much faster. In fact, with such a system, all it takes is a couple of seconds for you to place an order. Many traders use a rule based trading system to conduct high frequency trades, where they make hundreds of trades in just a single day.

Wrapping up

As you can see from the above, the benefits of trading through a rule based system are aplenty. Deploying such a system not only helps you overcome emotions that can hamper your trading strategy, but also provides you with several other investment benefits. Interested in starting with rule based trading? Wait till you see the next chapter of this module.

A quick recap

  • Of late, an increasing number of investors are turning towards rule based trading as a means to make money from the stock market. 
  • Rules based trading systems are very systematic since all of the trading decisions that it takes are defined through sets of rules and conditions. 
  • A major investment benefit that you get to enjoy through the use of such a trading system is customizability. 
  • Since every single trade is automated and happens only when the set criteria is met, there’s absolutely no chance of emotions creeping in. By keeping the emotions at bay, the system allows you to stick to your investment strategy. 
  • Another one of the benefits of trading using a rule based system is the fact that the system can be backtested before actually being put to use. 
  • Since all your trading activities are automated, the speed at which you place orders tends to be much faster.

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FAQ'S

Automated trading makes use of computer programmes and a set of predetermined rules to execute trades on behalf of the trader. The trader needs to set the parameters they need, such as the minimum profit, the maximum tolerable loss and so on, and the automated trading rules ensure that the trades are executed as per the individual’s requirements.
Yes. A rule based trading can be particularly useful in a volatile market. That’s because the prices of assets generally change very quickly in a volatile market. Under such circumstances, it may be impossible for you to manually execute trades as per your requirements. But a rule based trading system can do this for you easily.
While it is certainly possible, a rule based trading system is best suited for short term trades like intraday trading. That is because over the short term, price movements in the market can be more frequent. A rule based trading strategy can be of significant help here.
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