What Are the Benefits of Model-Based Trading?
Financial markets around the world conduct transactions worth billions of dollars on a daily basis. When you look around, investment options always appear to be endless. From stocks, futures, currencies, to bonds, there always seems to be something you can put your money on anytime. Understanding the risks and making sound investment choices in the financial market is however not easy. Investment managers, Forex experts at CMC Markets and market analysts spend all day crunching data just to find a stock that has the edge. But the human element involved means that there’s some margin for error. In order to reduce the risk and execute trades based on a predetermined strategy, a lot of investors are now considering model-based trading.
What is Model-Based Trading?
Model-based trading is the practice of using an automated trading system intelligently designed to provide objective and systematic trading. The thinking behind the integration of model-based trading is based on the need to minimize or remove emotion in making investment decisions. It’s also seen as a way of reducing or eliminating the cognitive biases of stock traders and reducing judgment errors during the course of daily trading. Essentially, model-based systems are designed to provide a swift, automatic, and objective trading solution void of any human decisions at the time of executing a trade.
Can Model-Based Trading Beat the Market?
There are a number of benefits that come with model-based trading. To start with, model-based trading removes the human emotion out of trading. This means that trades are executed objectively based on the available data. Remember that the financial markets can sometimes pile up the pressure on any investor leading to impulsive investment decisions that may lead to massive losses later. The objectivity that the model-based systems bring to the table is a huge advantage.
Also, model-based trading systems allow traders in the market to decide on what instruments to go for within a short period of time. Normally, a decision on whether to sell, buy or hold an instrument in the market would be based on critical analysis of data, market trends, and geopolitical situations around the world. This can take a lot of hours and by the time a decision is made, market conditions may have changed. But the argument for model-based trading is that these systems can, within a few minutes, crunch the numbers and analyze the data. This allows trades to be executed faster. Considering how dynamic the stock market is, a system that allows you to invest in instruments faster is an added advantage.
The practical application of model-based trading and the benefit it brings has already been proven. An article published on The Street last year showed that during the post-Brexit turmoil in global financial markets, hedge funds that used model-based trading systems performed better than those that didn’t. However, there’s still no empirical study that has established the effectiveness of model-based systems in trading. But even if you don’t use model-based systems for trading, they can still help to analyze and predict the risk in the market. There’s also the reduced risk of manual errors that can be made while placing the trade.
The rise of model-based trading systems has been quick and while there are very clear benefits that these systems offer, it’s still early to say whether they can beat the market or not. Nonetheless, the systems provide an option to simplify trading, reduce risks, and avoid the kind of impulsive investments that lead to losses.