Benefits of Algo Trading and Some Possible Hazards

First, let me make it clear that in this case, we’re talking about the differences between your personal investing account and the broader market with algo trading. In that sense then, this is a discussion of the differences between the micro-level and the macro-level.

Using a good algorithmic trading system, it’s possible to make money even in a bad market that’s either trading sideways or selling off.. You could even argue that that’s when algo trading really starts to come into its own, because it is during these times that individual investors will begin to let their emotions rule them. They’ll sell in a panic, rather than taking advantage of falling prices. Selling low and buying high is always a recipe for disaster, and this is why so many emotionally-driven investors ultimately fail.

Automated Trading Systems Don’t Panic

The reality is that automated trading systems consistently beat the stock market averages like the DOW Jones and S&P500 index, and a decent system that is constantly adjusting with the overall market trend and volatility is likely to continue to do so in the long run. The problem really isn’t for the individual investor, it’s that as more people will begin to rely on automated systems to handle their trades for them, and we could actually see a net increase in market volatility. Here’s why:

Algo Trading System

Imagine a system in which most trades are handled via automated trades. Even if there are a number of different automated systems on the market, the successful ones will all be successful due to their similarities. That means that they will all have pretty much the same buy/sell thresholds, so that when market conditions reach a certain predefined point (set up in the system’s trading parameters) it will trigger a buy or sell order.

Now multiply that buy/sell order across the entire market and observe what happens. Instead of just a few individual investors making the same buy/sell order, we’ve got hundreds of thousands of investors doing it, all at the same time. The upward or downward pressure on the price of whatever is being sold will be immediate and hugely impactful. The aggregate weight of all those simultaneous trades on the market as a whole will likewise be immediate and hugely impactful.

This is essentially what happened on “Black Monday” in 1987, when several automated trading programs triggered a massive wave of selling that caused the market to lose value very quickly. So quickly, in fact, that trading was suspended for the remainder of the day. And again for the more recent flash crash in May 2010.

You can expect these kinds of events to happen more frequently as more and more people begin to adopt various automated trading solutions. That’s not necessarily a bad thing, as many such systems are designed to make money even on downturns, but it is something to be mindful of. The same things that make algo trading a success will also likely breed more volatility into the system.

Algo Trading Is Still The Smart Way Forward

But for now most people aren’t smart enough to rely on automated trading.  They would sooner trust their “luck”, “instinct”, or some other dubious system.  So when you invest in an algorithmic trading system, you know you are way ahead of the herd.

Chris Vermeulen