Understanding the Basics of Algorithmic Trading
Over the years, algorithmic trading has become immensely popular and accounts for the majority of trading done across the world.
From the definition of algorithmic trading to its benefits, this article introduces the basics of algorithm trading for aspiring traders.
What is Algorithmic Trading?
Algorithmic trading utilizes a computer program that is programmed to a defined set of instructions. These instructions are based on the prices, timing, quantity, or mathematical models.
Based on the defined instructions, the computer program will keep an eye on the market and buy or sell stocks when the defined conditions are met.
Algorithmic trading removes the need for manual monitoring of the live prices and graph as well as manually placing orders.
Different Strategies in Algorithmic Trading
Some of the common algorithmic trading strategies to identify opportunities and minimize loss are as follows:
- Trend-following algorithmic trading strategies: Follow the market trends and take advantage of the market swing. This is the most common but highly volatile strategy that employs an easy and straightforward strategy to gain profit.
- Arbitrage algorithmic trading strategy: Uses price differential that involves the simultaneous sale of a stock that is bought at a lower price and sold at a higher price.
- Mean reversion algorithmic trading strategy: Involves the concept of reversion, which assumes that the assets’ prices, either high or low, are not a permanent occurrence and will revert back to their mean value.
Advantages of Algorithmic Trading
The main reason for the popularity of algorithmic trading is the numerous advantages that it has over manual trading. The primary benefits of algorithmic trading include speed, accuracy, backtest, and time-efficient.
Algorithmic trading can execute and scan multiple identifiers beyond human speed. The speed of trades is measured in fractions of a second, which is beyond human capabilities.
Algorithms are written before the instructions are executed automatically, which makes the process faster.
The great thing about using the computer in trading is the automation of trade execution, which avoids the accidental trade errors done by a human.
Furthermore, computer trading reduces human errors and other mistakes that are commonly associated with manual activities. The algorithm gives a more logical decision based on numbers and statistics without getting carried away by human emotions, which typically results in an irrational decision.
Researching through the past data to know what trading systems work and what doesn’t can be daunting. Algorithmic trading has the ability to backtest and run an algorithm based on past data to determine the profitability of a system.
Algorithmic trading saves traders on time spent constantly monitoring stocks. The trades can be executed automatically without the supervision of traders.
Besides the benefits mentioned above, other benefits of algorithmic trading include:
- Execution of trades at the best price possible
- Instant placement of an order at the desired levels
- Correctly timed trades that prevent significant changes in the price
- Automated checks on multiple markets at the same time
With the widespread acceptance and usage of algorithmic trading in the trading and financial world, learning the essentials of algorithmic trading may deem profitable and beneficial for traders.