An automated trading system ATS is a computer program that creates orders and automatically submits them to a market center or exchange. The program will automatically generate orders based on predefined set of rules using a trading strategy which is often based on technical analysis but can also be based on input from other electronic sources.
Automated trading systems are often used with electronic trading in automated market centers , including electronic communication networks , " dark pools ", and automated exchanges.
Traditional risk controls and safeguards that relied on human judgment are not appropriate for automated trading and this has caused issues such as the Flash Crash. New controls such as trading curbs or 'circuit breakers' have been put in place in some electronic markets to deal with automated trading systems.
Trading strategies differ; some are designed to pick market tops and bottoms, others to follow a trend, and others involve complex strategies including randomizing orders to make them less visible in the marketplace. ATSs allow a trader to execute orders much quicker and manage their portfolio easily by automatically generating protective precautions. Backtesting of a trading system involves programmers running the program using historical market data in order to determine whether the underlying algorithm guiding the system may produce the expected results.
Developers can create backtesting software to enable a trading system designer to develop and test their trading systems using historical market data to optimize the results obtained with the historical data. Although backtesting of automated trading systems cannot accurately determine future results, an automated trading system can be backtested using historical prices to see how the system theoretically would have performed if it had been active in a past market environment.
Forward testing of an algorithm can also be achieved using simulated trading with real-time market data to help confirm the effectiveness of the trading strategy in the current market and may be used to reveal issues inherent in the computer code. Live testing is the final stage of the development cycle. In this stage, live performance is compared against the backtested and walk forward results. The goal of an automated trading system is to meet or exceed the backtested performance with a high efficiency rating.
Improved order entry speed allows a trader to enter or exit a position as soon as the trade criteria are satisfied. Furthermore, stop losses and profit targets can be automatically generated using an automated trading system.
Automated trading or high frequency trading causes regulatory concerns as a contributor to market fragility. United States regulators have published releases   discussing several types of risk controls that could be used to limit the extent of such disruptions, including financial and regulatory controls to prevent the entry of erroneous orders as a result of computer malfunction or human error, the breaching of various regulatory requirements, and exceeding a credit or capital limit.
The use of high-frequency trading HFT strategies has grown substantially over the past several years and drives a significant portion of activity on U. Although many HFT strategies are legitimate, some are not and may be used for manipulative trading. Given the scale of the potential impact that these practices may have, the surveillance of abusive algorithms remains a high priority for regulators.
FINRA has reminded firms using HFT strategies and other trading algorithms of their obligation to be vigilant when testing these strategies pre- and post-launch to ensure that the strategies do not result in abusive trading. FINRA continues to be concerned about the use of so-called "momentum ignition strategies" where a market participant attempts to induce others to trade at artificially high or low prices. Examples of this activity include layering and spoofing strategies where a market participant places a nonbona fide order on one side of the market typically, but not always, above the offer or below the bid in an attempt to bait other market participants to react to the non-bona fide order and trade with another order on the other side of the market.
FINRA also continues to focus concern on the entry of problematic HFT and algorithmic activity through sponsored participants who initiate their activity from outside of the United States. FINRA conducts surveillance to identify cross-market, cross-product manipulation of the price of underlying equity securities, typically through abusive trading algorithms, and strategies used to close out pre-existing option positions at favorable prices or establish new option positions at advantageous prices.
In recent years, there have been a number of algorithmic trading malfunctions that caused substantial market disruptions. These raise concern about firms' ability to develop, implement and effectively supervise their automated systems.
The Financial Industry Regulatory Authority FINRA has stated that it will assess whether firms' testing and controls related to algorithmic trading and other automated trading strategies and trading systems are adequate in light of the U. Securities and Exchange Commission and firms' supervisory obligations.
This assessment may take the form of examinations and targeted investigations. Firms will be required to address whether they conduct separate, independent and robust pre-implementation testing of algorithms and trading systems and whether the firm's legal, compliance and operations staff are reviewing the design and development of the algorithms and trading systems for compliance with legal requirements.
FINRA will review whether a firm actively monitors and reviews algorithms and trading systems once they are placed into production systems and after they have been modified, including procedures and controls used to detect potential trading abuses such as wash sales, marking, layering and momentum ignition strategies.
From Wikipedia, the free encyclopedia. Soft Dollars and Other Trading Activities ed. Commodity Futures Trading Commission. Retrieved December 22, Retrieved 21 September How to Evaluate an Automated Trading System". European Central Bank This supports regulatory concerns about the potential drawbacks of automated trading due to operational and transmission risks and implies that fragility can arise in the absence of order flow toxicity. Archived from the original on High-Frequency Trading's Rise and Fall".