What is algo trading?
Algo trading, also known as algorithmic trading, is an electronic financial market trading process in which trades are executed by computer programs. These computer programs work on predetermined algorithms (algorithms) to make trading decisions based on market data. These algorithms help in taking decisions for trade rules, timing, price or volume.
Algo trading originated and developed in the 1980s and 1990s, when computer technology and high-frequency trading (HFT) began to become popular. The main objective of algo trading is to reduce human errors by automating the trading process and to bring consistency and speed in trade execution.
Features of algo trading :
Speed: Algo trading uses computers to execute trade orders at lightning speed. Here trade decisions are taken in milliseconds.
Accuracy: Algo trading systems have very high accuracy levels. It makes trade decisions according to pre-determined algorithms, thereby reducing the influence of human emotions or biases.
Backtesting: Algo trading systems can be tested on historical market data to analyze their performance and profitability.
Liquidity: Even large order dimensions can be easily executed through algo trading, as it is an automated process.
Arbitrage: Algo trading is also used to capture arbitrage opportunities. In this, a security can be bought at a lower price and sold at a higher price.
Market Making: Some algo trading strategies facilitate market making, thereby providing liquidity by reducing the bid-ask spread.
Quantitative Analysis: Quantitative analysis is used in the design of algo trading systems to optimize trading strategies.
Algo trading also has some challenges, such as technology failure, market variability, regulatory quarantine, and algorithmic errors. Therefore, algo traders need to monitor their systems regularly.
Many banks, financial institutions, hedge funds, and trading firms around the world use algo trading. These trading strategies are very complex and require the expertise of experienced quantitative analysts and traders to develop.
To explain this again, as an example, imagine that a trader has designed an algo trading system that looks for certain patterns in the market. When this pattern is discovered, the system automatically places buy or sell orders.
Algo trading is a dynamic field that is used to streamline the trading process in the financial markets. This provides traders with the opportunity to ensure that they execute their trades at the best price and manage risk.
Please note that before trading in the financial markets you are advised to understand the risks and regulations involved and seek advice from a qualified financial advisor.
Advantages of Algo Trading –
- With the help of algo trading, you can create code in the stock market, through which you can easily use segments like equity, forex commodity.
- In algo trading, the computer program itself takes decisions about investment. In such a situation, the possibility of error remains very less or nil.
- Viewing different instrument indicators through the same computer program helps in trading.
- Since algo trading is completely automated, the chances of missing a trading opportunity are negligible.
Disadvantages of algo trading –
- Algo trading is being called the future of trading in the coming times.
- With changing times, it can be further improved through technology.
- To do algo trading, more money is required in terms of investment, so that you can invest.
- At present there are some flaws in algo trading such as if there is a mistake in calculation then one has to suffer huge losses.
- If you are new to the stock market then you should avoid algo trading as it is a bit difficult technically.
- For this a different kind of special strategy has to be adopted.
- Even though algo trading is completely automated. But it is important to take care of it daily so that its flaws can be detected.
- After some experience, you can first start doing algo trading.