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With all the allegations of Mt. Gox’s automated trading bot, which has been dubbed “Willy”, algorithmic trading is getting a bad rap. So, how do these bots work, and can they really make you money? Trading bots are software programs that talk directly to financial exchanges, and place buy and sell orders on your behalf. They make those decisions by watching the market’s price movements, and reacting according to a set of predefined rules. Joseph Lee is living proof that they can make money.
Lee, who founded derivatives exchange BTC. 200,000 in profits using his private software army. While that seems astonishing, the devil is in the detail, of course: a lot of that price increase stems from the massive price increase in bitcoin late last year. In fact, the real profits are far more marginal, he has said, so don’t expect to install a plug-in and write your own rags-to-riches story. Market maker Lee’s first trading bot used inter-exchange arbitrage, noticing differences in prices between orders on different exchanges, and buying on some exchanges while selling on others. I was essentially taking liquidity from a market where there was some and injecting it into a market where there wasn’t,” he explained.
Gox dominated the market, and other exchanges had poor pricing because their supply of bitcoins was limited. So, I bought for cheap on Mt. Gox and sold them to other markets. I bought a lot of bitcoin into tertiary markets.
In short, he acted as a market maker on less-established exchanges. Established practice Lee may have written his own bots, but today, the bitcoin trading bot market is far more established, with several available off the shelf. Trading by algorithm isn’t new in the financial world: companies in the conventional financial markets have been using the method for years. This enables individual traders to have their computer access the exchange’s electronic order books directly. That’s a service normally only available to brokers and investment houses in the conventional markets. 10,000-plus a year Bloomberg terminal with an API connection who could try their hand at bot trading,” Lee explained. So, why isn’t everyone doing it?