The Basics Of A Trading Algorithm

Trading Algorithm: The advancement in computer technology has allowed investors to put their trading decisions on autopilot. Each day, more and more traders are considering the use of algorithmic trading. It is a system that bases its transaction decisions on highly advanced mathematic models. The rules built into the program allow the user to conduct a thorough analysis into the financial markets which includes determining the optimal time to purchase, calculating the risk factor of trades and developing a strategy through such an analysis.

Although this method was commonly used by large institutional investors, nowadays smaller investors have also started using it to purchase small lots of shares for the varied advantages it offers. The software collects important market stats and thus saves time and effort you would have otherwise spent on the same task. Also, its accurate and quick calculations help you make near accurate predictions about the market putting you in a highly advantageous position.

Trading algorithm is nothing but the mathematical models the system uses

These trading algorithms address two vital questions.

  • When to trade
  • How to trade

The optimal time to trade is determined on the basis of the changes in the market. It is these fluctuations that create purchase and sale opportunities. This means keeping a close watch on the market. The manner in which you should trade involves deciding how to place and manage orders so as to maximize profit and minimize risk.

The trading algorithm is formulated on the basis of historical market data following which they are updated with real time information. GAATS is the most common algorithmic formula. It constitutes the seven proprietary algorithms that were developed.

Many traders ask about developing their own trading algorithms as against using readily available ones. Formulating an algorithm is a lengthy process. In addition to developing the formula, you have to update it constantly. Along with this, you have to test it over several weeks and months to make sure it functions in the desired manner. That is the reason why it is better to use genetic algorithms to cut development time.

You can start by creating a simulated market. It generates false data in close imitation of the real markets using statistical analysis based on past market data. It takes into consideration the price of stocks and the increments in the price of stocks over a specified period of time and thereafter comes up with a random price point. Thus, a trading algorithm helps you make a more informed decision concerning your transactions in the financial market. You will be able to buy and sell shares in a profitable manner.

In your research on the efficiency of trading algorithms, you might come across a number of reports discussing its limitations. They include the poor predictive abilities of algorithms or its inability to function in highly stressful markets.  These rumors are mostly floated by traders and brokers who fear that they will soon be replaced by computers.

Automated trading software makes use of advanced algorithms to determine the right time to place orders and execute trades. A well-designed trading algorithm does this without influencing the cost of the trade.