By Vishweshwar HS, www.showmytrade.com
The advent of computer technologies and software made it possible to automate trading activities. Algorithmic or Algo trading refers computer program designed to follow a set of instructions to plan and execute the trade by itself. Algo trading, in theory, generates defined profits with acceptable risk. The frequency and quantity of trade are something unmatched for a human trader. They are also called automated trading or proprietary black-box trading etc.
The Algo trading executes sets of instructions based on timing, price, quantity, or any mathematical model. Algo trading facilitates more liquidity and avoids the impact of human emotions on trading activities.
Initially, Algo trading was widely used by big institutions like investment banks, pension funds, mutual funds, and hedge funds. These users need to execute large orders in a rapid time. Now, even small traders also can use Algo trading to make profits from the stock market.
A simple example of Algo trading
Mr. Subramaniam wants to take a trade on 50 Simple Moving Average (SMA) Crossing 200 Simple Moving Average (SMA), golden crossover strategy.
His Algo trading system buys 100 shares of a stock when its 50 SMA goes above the 200 SMA. And
Sell shares of the stock when its 50 SMA goes below the 200 SMA
Algo trading can carry these simple instructions and automatically execute them when they find such conditions in real-time. Mr. Subramaniam needs not monitor the market as a system does the entry and exit automatically.
For successful Algo trading, one needs trading strategies to program the computer to identify a profitable trading opportunity. Several strategies can be applied to Algo trading. Some of the common trading strategies include:
Algo-trading is used by many users from small traders to big institutional traders, simple trading strategies to complex, multi-market, very sophisticated proprietary software/platforms. Algo-trading is used for both trading and investment purpose. Some of the users include:
Long-term/Buy only investors: The market makers like pension funds, mutual funds, insurance companies. Use Algo trading for purchasing large quantities of stocks/instruments from multiple markets without alerting much to the stock operators.
Short-term/(Buy-Sell) traders: The small traders, Brokerage firms, speculators, and arbitrageurs use Algo trading as this provides them speed and accuracy. These participants contribute to the overall liquidity in the system.
Different market participants: The system-based traders (follow entry & exit strategy every single time continually). Hedge funds are looking for alpha in the world stock market. The pairs traders (buy entry and sell entry in highly correlated stocks. Use Algo trading for their advantage to exploit various market anomalies to make a profit.
Most Algo-trading today is done by high-frequency traders (HFT). Automated trading executes a large number of orders at rapid speeds across multiple markets and multiple decision parameters based on preprogrammed instructions.
In modern days, Algo-trading evolved into a sophisticated trading tool. Innovative Hardware, software, machine language, Artificial Intelligence, High-speed networks made it possible to trade very high quantity trading instruments across the world. In most of the world’s stock market, around 60-80% of entire trading volumes are done by automated trade. In India, too, Algo trading is widely adopted. Professional traders should learn Algo trading.
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Good Earning!
