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What Investors Need to Know about Auto-Trading Programs

Investors can "automate" trading on their account by signing up for an auto-trading program. Under an auto-trading setup, securities transactions are automatically processed and executed by your broker.

How Auto-Trading Works

Auto-trading is one of the services offered by some investment newsletters. To open an auto-trading account, you must first subscribe to an investment newsletter. Once subscribed, you have to open a trading account with the brokerage firm your investment newsletter recommends.

To open your brokerage account, you have to sign an agreement that gives your investment newsletter publisher discretionary authority over your account. Specifically, this agreement authorizes your broker to act on the investment newsletter's recommendations without first notifying you or seeking your permission.

Upon signing the agreement, you have to deposit money in your account. Trade will be executed whenever the investment newsletter instructs your broker to do so.

The Pros and Cons of Auto-Trading

Auto-trading programs have several benefits, and they include the following:

  • Auto-trading is convenient. You won't have to micromanage since trades are executed automatically.
  • Auto-trading means timely execution of trades. In trading, timing sometimes means the difference between earning and losing money. Since trades are automatically executed, there's no delay in processing lucrative transactions.
  • Auto-trading benefits new investors. Inexperienced investors who are still learning the ropes gain guidance from experts.

Auto-trading, however, also comes with great risks, and they include the following:

  • You have minimum control over trading decisions. Your endorsement is not required before a trade is executed. A trade you wouldn't have made had you been aware of it will be processed if your investment newsletter recommends it.
  • You may find yourself heavily invested in companies that pay your investment newsletter service for referrals. This translates to opportunity cost on your part. The money you could have used to invest in top market performers might be tied up in mediocre securities instead.
  • You may not be able to act on good trading opportunities. If your investment newsletter service has all of your assets tied up elsewhere, you may not have enough liquidity to cover potentially lucrative trades that come your way.
  • You can lose a lot of money. If your investment newsletter makes a particularly bad trade recommendation, you can lose a lot of money.

Before Signing Up for an Auto-Trading Program

The greatest risk in auto-trading comes from the fact that trades are executed without your knowledge and permission. To minimize the risks of auto-trading, choose your investment newsletter service carefully. Make sure the one you choose can be trusted to give you good and unbiased advice.

The following are some tips that will help you minimize the risks of auto-trading:

  • Choose only a legitimate investment newsletter service. Investment newsletter publishers should be registered as investment advisers with SEC.
  • When opening a brokerage account for auto-trading purposes, verify the registration status of the broker that the investment newsletter service has recommended. Find out, too, if there have been complaints filed against it.
  • Ask the investment newsletter company about their performance and track record. Do not settle for press-release materials. Especially elicit information about some of the firm's bad recommendations. No investment newsletter service can be right all the time. One that claims just that can only be lying.
  • Investigate the investment newsletter service's affiliations. Find out if the investment newsletter service receives a commission for channeling buyers to certain companies. In this case, a conflict of interest may exist. Bad recommendations may be made in the name of commission earnings.
  • Avoid investment newsletter services that rely on client testimonials to market their services. First of all, most of such testimonials - even if they're true - are most likely skewed in the investment newsletter's favor. Moreover, using client testimonials is forbidden to investment advisers by SEC laws. Investment newsletters that use client testimonials are obviously violating SEC rules. How can you trust such a service to stay on the straight and narrow?
  • If you know people who are subscribed to the investment newsletter you're considering, talk to them. Ask them how good (or bad) they judge the service's performance to be.
  • Try out an investment newsletter service before you sign up for its auto-trading program. During the trial period, observe how right on the money (or off the mark) the service's recommendations are. Only if an investment newsletter proves its merit should you even consider signing up for its auto-trading program.
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