How does the trading bot work? A comprehensive guide for beginners

Cryptocurrency markets operate 24/7, making it impossible to monitor them around the clock. That’s why an increasing number of investors are turning to AI-powered trading bots to optimize their positions and enhance profitability.

What exactly is a cryptocurrency trading bot?

A cryptocurrency trading bot is an automated program that uses artificial intelligence and advanced algorithms to execute buy and sell orders without manual intervention. It functions as a digital assistant, processing vast amounts of market data, recognizing price patterns, and executing trades based on pre-programmed strategies.

According to data from Dune Analytics, leading crypto bots have generated over 29,000 ETH in revenue as of September 2023, with Maestro dominating the market with over 13,000 ETH. This figure indicates that trading volume through bots has become an integral part of the crypto ecosystem.

The main advantage of cryptocurrency trading bots is their ability to operate continuously 24/7. While you sleep or are busy, they can still seize market opportunities and execute timely trades. Through automation, you can eliminate emotional factors from trading and follow strategies with discipline.

Detailed operation process of a trading bot

To understand how a trading bot works, you need to grasp the five main steps in the trading cycle:

Step 1: Data collection and analysis

The bot constantly gathers data from the market, including historical prices, trading volume, order book data, and technical indicators. It processes this information to identify trends, support and resistance levels, and anomalies that may signal trading opportunities.

Step 2: Generate trading signals

Based on analysis, the bot creates signals indicating whether to buy or sell. These signals often rely on technical indicators such as moving averages (SMA), RSI (Relative Strength Index), MACD (Moving Average Convergence Divergence), or other custom formulas.

Step 3: Set risk management parameters

Before executing trades, you need to configure risk parameters. This includes the maximum percentage of your portfolio allocated to a single trade, stop loss (stop loss), take profit (take profit), and other rules to protect your capital.

Step 4: Execute trades

When all conditions are met, the bot connects to the exchange’s API to place buy or sell orders automatically. It monitors the status of each order and manages your portfolio in real-time.

Step 5: Continuous monitoring and adjustment

The bot does not stop after executing a trade. It continuously monitors the market, compares actual performance with the strategy, and can adjust parameters such as entry/exit points, stop loss, and take profit based on market changes.

There are two types of trading bots you should know

The first type requires connecting via API to cryptocurrency exchanges. They demand higher technical knowledge to set up and manage but offer greater flexibility.

The second type is pre-integrated bots on trading platforms. These are easier to use, have user-friendly interfaces, require no programming skills, and can be configured with just a few clicks.

Can you make profits from trading bots?

The answer is yes, but not always. Profitability depends on many factors:

Market conditions

Cryptocurrency markets are volatile and unpredictable. Bots perform best when the market has clear trends or normal volatility. During sudden crashes or crises, even bots may struggle. However, well-designed bots with strong risk management strategies can still generate profits in such situations.

Quality of trading strategy

A bot’s performance entirely depends on the programmed strategy. A good strategy aligns with your trading goals and risk tolerance. You should backtest (backtesting) data to evaluate the strategy’s effectiveness before deploying it live.

Accurate bot configuration

How you set up the bot determines the final outcome. Entry and exit points, stop loss, take profit—all need careful adjustment. You must monitor regularly and tweak these parameters as market conditions change.

Proper risk management

While bots can avoid FOMO (fear of missing out) and trade emotionlessly, risk management remains crucial. You need to understand potential risks, avoid relying solely on the bot, and be ready to disable it or adjust strategies if necessary.

Active supervision

Automation does not mean you can forget about the bot. Market conditions change rapidly, and continuous monitoring is essential to adjust parameters or stop the bot when needed.

According to trading platform data, users have created and used over 12.7 million trading bots with various strategies. This indicates that crypto trading bots have become a popular tool within the investment community.

Popular types of trading bots today

Spot Grid Bot (Spot Grid)

This bot performs well in range-bound markets. It places buy and sell orders at regular intervals, aiming to profit from price fluctuations. When prices oscillate within a certain range, the bot can execute multiple small trades to accumulate gains.

Futures Grid Bot (Futures Grid)

Designed for futures trading. This bot can leverage up to 10x, maximizing potential profits but also increasing risk. It allows trading both long (long) and short (short) positions, creating opportunities to profit whether the market goes up or down.

Martingale Bot

A high-risk, high-reward strategy. The bot increases trade size after each loss, aiming to recover losses with larger subsequent trades. Suitable for traders willing to accept calculated risks and trust in the asset’s recovery potential.

Smart Rebalance Bot (Smart Rebalance)

To maintain a balanced portfolio, this bot automatically buys low and sells high based on predefined allocation ratios. It helps keep asset allocation balanced and reduces concentration risk.

Infinity Grid Bot (Infinity Grid)

Using unlimited grid layers, this bot is ideal for developing markets. It continuously buys low and sells high, with unlimited growth potential, especially effective during bullish market cycles.

DCA Bot (Dollar-Cost Averaging)

A dollar-cost averaging strategy where you invest a fixed amount regularly into a specific cryptocurrency regardless of current price. The bot automates this process, reducing the impact of short-term volatility and suitable for long-term investors.

AI Adaptive Bots

The latest bots utilize AI technology to automatically adjust strategies based on changing market conditions. They can operate efficiently in both bullish and bearish markets, with automated risk management through take profit and stop loss orders.

Are trading bots safe to use?

Generally, trading bots are safe if you choose reputable providers. Here are some points to consider:

Choose reputable platforms

Look for platforms with good reputations, prioritize data security, and offer reliable services. Check user reviews to understand their experiences. A good platform will use HTTPS, two-factor authentication (2FA), encrypt sensitive data, and have secure fund storage systems.

Limit API permissions

When connecting the bot to an exchange, grant only necessary API permissions. Avoid granting withdrawal rights to minimize risks in case of security breaches.

Use demo mode first

Most bot providers offer testing or demo modes. Use these to familiarize yourself with features and performance before risking real funds.

Regular updates

Select bots that receive frequent updates and security patches. This ensures vulnerabilities are addressed promptly.

Reliable customer support

Ensure the provider offers dependable customer support to resolve issues when they arise.

Personal risk management

Always follow your own risk management strategy. Define your risk tolerance, set stop-loss orders, and monitor performance regularly. Start with small amounts and increase as you gain experience.

Remember, no system is completely safe. Risks always exist in cryptocurrency trading, and trading bots do not guarantee profits.

Conclusion

Cryptocurrency trading bots have become valuable tools for traders and investors. They offer clear advantages: 24/7 automated trading, fast execution, emotional removal, portfolio diversification, and process automation.

However, it’s important to understand that bots are tools to assist, not replace human analysis. Factors such as choosing the right strategy, proper configuration, good risk management, and continuous supervision determine the final results.

Crypto trading carries high risks, and trading bots are not a panacea. Keep learning, experiment with different strategies, and start with small investments. Only when you are confident in the bot’s performance should you scale up your trading volume.