The Most Important Thing In Automated Trading? Probably Procedures To Avoid Mistakes

Last Updated on March 6, 2021 by Oddmund Groette

Chapter 4 in Victor Niederhoffer’s book Education Of A Speculator starts like this:

There are so many ways to lose, but so few ways to win. Perhaps the best way to achieve victory is to master all the rules for disaster and then concentrate on avoiding them.

Some days ago I wrote about my trading day and my procedures. For me it’s extremely important to do everything in the correct order/procedure. This is to avoid mistakes.

I’m mostly an automated trader. This gives me opportunities to trade and diversify more. But with automation comes a risk if something goes wrong. Do you remember Knight? They updated their robot and forgot to test it. Too bad for them, the program went crazy and sent a lot of erroneous sell orders. They pushed prices down and they didn’t manage to stop until they had lost about 500 million USD. A lot of this prey was taken by individual day traders like me. It was a very good day. Unless, of course, you’re not the one being preyed upon!

With automation, it’s extremely important to do things in the correct order and to make sure all programs are set correctly before the open. To avoid mistakes I need to follow my procedures, just like airline pilots. There is a reason why pilots need to follow every procedure: one mistake can lead to a crash. It’s the same with automation. One mistake and you lose your account. I never want to rush anything when preparing for the trading day. I have fellow traders who have lost 100 000 in seconds just because of fat-finger errors. I try to make all kinds of bells and whistles to make sure all is correct.

What kind of procedures do I need to do? All of these are very tedious and boring. But I want to avoid them at all costs. I remember the “unsinkable” Titanic. Before every trading day I need to do the following: check for correct closing prices in my trading software, all formulas must be correct and tickers with news must be removed. After that, I send just a small sample and calculate it manually. I can assure you the following: if anything can go wrong in automation, a serious mistake will happen sooner or later. It’s just a question of time.

Let me give you some examples:

Before Christmas I had problems updating my quotes right after the open. I had to restart my Excel sheet, but in the hurry, I forgot to exclude news stocks (I don’t trade news). That cost me 1 000 USD. Not a great amount, but nevertheless unnecessary. This happened because my procedures were disturbed and I was in a hurry.

No, let me tell you what happened to a trading colleague. He is still a little wet behind his ears and does not have much experience.

In January he started trading a new strategy, fully automated. The strategy requires a lot of calculations, and he failed to double-check calculations in his code manually. Result: Limit prices were completely off and of course led to losses. It was a huge mistake but he was lucky and lost only 500 USD. This error could have cost him tens of thousands of dollars.

Did he learn from this mistake? Unfortunately not. 3 weeks later it happened again:

This time he made some changes to an already existing strategy. Unfortunately, in coding, he typed “2” instead of “1” in one place. Result: hundreds of orders were sent short instead of long. Again he was extremely lucky and only lost 700. The loss could have been 50 000. This is why it’s so important to double-check all code after any changes and test on a small sample before using the whole sample of stocks.

Just 4 days after this a new error occurred: When closing down trading for the day some 30 mins before close, he was unaware a lot of orders were still in the market. Of course, he got filled on some of those and lost 300 USD. Yet again, extremely lucky to not lose more. Lesson: always log out and in to double checks all is ok. All with trading needs to be double-checked. Unnecessary mistakes are a real drag on performance. During a year all these mistakes add up quite much. And some really serious mistakes can force you to stop trading altogether.

Moral: everything that can go wrong needs to be double-checked. And preferably before learning from mistake….. And always test on small samples first.

However, mistakes will inevitably happen, but you need to minimize them as much as you can. In my EOD trading, I have also done some mistakes: for two weeks I accidentally had a calculation error in my sheets. I of course lost money before I realized what was wrong. I send a lot of orders overnight and use an Excel macro to close them. Even after double-checking manually, I didn’t spot this formula error in my spreadsheet.