Algo Trading: What it is and how does it work?
Algothrium Trading is popularly known as Algo Trading. It uses a computer program that follows an algothrium in which trade works. An algorithm is a certain set of simply detailed instructions that aim to carry out a task or process.
There are times when the work burden is so dense that a human trader is not able to tackle large numbers of trading, and when that happens you need the intrusion of a smart algorithm.
In algo trading, the need for a human trader’s interpretation is minimized and so the decision making is very fast. This enables the system to take advantage of any profit-making opportunities that are arising in the market much before a human trader can even spot them.
How does algo trading help?
Algo trading is certainly the most needed by clients for online trading. These algorithms input every mathematical quote and trade in the stock market. Algothrium helps in recognizing liquidity occasions and then turns the details into smart trading decisions.
Algo trading rips down transaction prices and permit investment traders to control their own trading processes. Algorithm alteration gives offer returns for firms with the scale to consume the costs and to get the benefits.
How does Algo Trading work?
Algo trading or algorithm trading is a step-by-step process of using computer design programs to accompany a interpret set of details for working a trade in order to get enormous profits at accuracy and frequency that’s not possible for a human trader. Any master plan for algorithmic trading needs an identified occasion, that has profitable earnings or cost reduction.
The algo trading strategies follow interpret sets of rules and are established on timing, price, quantity, or mathematical model. Apart from profit occasions for the trader, algo trading makes stock markets additional liquid and makes trading more structured by decision out humans emotions that impact on trading business.
Let’s understand this with an example:
If a trader has applied 10 different strategies on a stock — here we are talking about one stock — the system will suggest variations. Out of these 10 strategies, if 7-8 show buys signals, the market participant will buy the stock. As the majority of the strategies are showing buy signals, it is natural to believe that the strategy will be favorable.
Pros of Algo Trading
1. Best possible price
Traders can get trade at the executed best possible prices.
2. Trade Placement
Traders get instant and accurate trade order placement.
Traders Trade timely, correctly, and instantly. This avoids significant price changes.
Reduced transaction costs due to lack of human interference.
5. Works automatically
Simultaneous automated checks on more than one market condition.
6. Fewer errors
Reduced risk of errors in placing the trades.
7. Fewer mistakes by a human trader
Reduce chances of mistakes by human traders based on emotional factors.
The largest portion of present-day Algo trading is high-frequency trading (HFT). This trading method attempts to make capital out of placing an enormous number of orders at very fast accuracy, across multiple markets, and multiple decision parameters, based on pre-programmed instructions.
Algo Trading can be applied in many investment activities:
Mid to long-term traders- Mid to long term traders mean pension funds, mutual funds, insurance companies that purchase stock in enormous quantities but don’t want to influence stock prices with discrete long term investments.
Short-term participants- Short-term participants are markets makers, speculators, and arbitrageurs. Benefit from automated trade execution. Algo trading aids in creating accurate liquidity for sellers in the market.
Systematic traders- Systematic traders are like trend followers, pairs traders, hedge funds e.t.c. efficient work in the trading rules and let the program trade automatically.
Requirement for Algo trading
1. A computer system that can read present market prices.
2. Price sustains from LSE and AEX.
3. A foreign exchange rate sustains the exchange rate.
4. Has the ordering capability which can route the order to correct the exchange.
5. Back-testing capability on historical price sustain.
The smart investor needs to understand risks and challenges. For example, system failure risks, time-lags between trade orders and execution, network connectivity errors, and, most important of all, imperfect algorithms. Always set on the reminder, if you place an algo generated trade, so do the other market participants. The more complex an algorithm will be, the more tough backtesting is needed before it’s put into action.
In this type of system, the need for a human trader’s interpretation is minimized and so the decision making is very fast. This enables the system to take advantage of any profit-making opportunities that are arising in the market much before a human trader can even spot them.
As the large institutional investors deal in a large number of shares, they are the ones who make large use of algo trading.
Implementing the algorithm using a computer program is the final component of Algo trading, accompanied by backtesting. The challenge of Algo trading is to transform the identified strategy into a combined artificial intelligence process that has access to a trading account for placing orders.
The things that are needed for Algo trading were discussed earlier. The basic thing that you need is computer-programming knowledge to program the required trading strategy, hired programmers, or pre-made trading software. Moreover, you need Network connectivity and access to trading platforms to place orders.
The important thing to keep in mind is to Access market data feeds that will be monitored by the algorithm for opportunities to place orders. Always remember the ability and infrastructure to backtest the system once it is built before it goes live on real markets.