Should You Use a Trading Bot to Buy Bitcoin?

Tempted to try a trading bot? Make sure you understand the risks.

Cryptocurrency investment became a lot more mainstream in 2020. Well-known banks and brokerages launched crypto services. Institutions bought Bitcoin. And the S&P Dow Jones announced it would launch a cryptocurrency index this year.

If you want to buy Bitcoin or any other cryptocurrency, you can do so by using a brokerage, exchange, or app. The right one depends on your investment strategy, the available coins, and whether you want to stake your coins (which offers rewards and risks akin to those of a dividend-paying stock).

But the top exchanges and apps aren't the only thing you need to get to grips with. As you venture further into the world of Bitcoin, you might also come across trading bots.

What is a trading bot?

A trading bot can automatically buy and sell cryptocurrency according to preset parameters. For example, you can program the bot to make trades based on certain trends. And the bot may let you test out your strategies using simulations and historical data.

You'll find a range of bots on the market. Some are free, and others cost anything from $10 to $100 a month. Each has its own algorithm. Some offer pre-built programs, while others help you write your own scripts. An arbitrage bot, for instance, can compare prices across various exchanges, and capitalize on any price differences.

Unlike the stock market, the crypto market doesn't have fixed hours. And unlike a human being, a bot can watch the markets 24/7. Given the dramatic changes that can happen in a short space of time in the crypto world, you can see the appeal of a helpful bot that never sleeps.

Sounds great, right? Unfortunately, it's not that simple.

If you're more familiar with stock investments, you might think a trading bot will work like a robo-advisor. A robo-advisor can automate your investments based on your risk tolerance and other factors. But the crypto bots on the market right now can't automatically adjust your portfolio based on your answers to certain questions. You have to give the bot a lot more instruction.

Before you can work with a bot, you need to understand the fundamentals of cryptocurrency trading. If you don't know the details of how to trade, a bot can't help you. In addition, many of the bots on the market are not easy to use. In fact, you may need programming experience to set up the algorithms.

That's part of the reason many crypto investors are hesitant to use bots. A number of crypto threads on Reddit warn of the dangers and potential losses of bots. It takes significant amounts of time and knowledge to profit with a bot.

A buy-and-hold approach (called "HODL" in crypto circles, thanks to a now-notorious misspelling in a Bitcoin forum) makes a lot more sense in the long term, especially if you're just starting out. Research coins and buy ones you believe will perform well over time. Investing based on fundamentals takes a lot of the stress out of investing by removing worry about short-term fluctuations. And you don't need a bot if you're not trying to trade all the time.

Bots also bring the danger of software glitches and system crashes. The bot could accidentally buy or sell your assets, or not function at a crucial time.

Finally, there's an increased risk of hacking and scams. The more places you store your data, the more risk there is. There's a reason security is much more of an issue in crypto investments. Unlike a bank account or stock exchange, if your crypto is stolen, you're unlikely to get it back. Many crypto exchanges and wallets are not SIPC or FDIC insured. Some exchanges have some protections in place, but there's no guarantee.

Should you use a trading bot?

Trading bots do have their benefits. A bot can take some of the emotion out of your investment decisions. Many investors panic when the value of an investment plummets. Bots may stop you from panic-selling or buying a coin simply because everybody else is.

Bots also react more quickly to any given situation. You can program your bot to react to certain market triggers, which may allow you to sleep better at night.

Ultimately, like many tools and computer programs, the bots are only as good as the instructions they get. If you're just starting out, using a bot to buy bitcoin could be akin to using a sledgehammer to drive in a thumbtack. It's a powerful tool that could put a huge dent in your finances.

If you decide to use a bot, make sure it's reputable. Start with a small amount of money and run simulations before you set it loose on live trades. And once the bot is up and running, don't sit back and ignore it -- check in regularly to ensure it's working as you planned.