The algorithmic trading is also referred as black box or automated trading. Basically, algorithmic trading is a strategy in which powerful computers control all the trade and there is a minimum involvement of humans.
There are a lot of benefits of algorithmic trading because it is hard to achieve the profits by humans, which algorithmic trading has made easy.
However, this method of trading is gaining popularity, as there is no need to monitor the trade so the traders can easily trade multiple stocks at a time.
Let’s discuss in detail about the benefits of algorithmic trading, how to do it and what are some drawbacks of using it.
Benefits Of Algorithmic Trading
There is a long list of the benefits of algorithmic trading system, but we have listed a few of them below;
Speed is the most important factor that affects trading. In algorithmic trading, trades are quickly executed by examining various parameters and technical indicators.
High-frequency trading (HFT) is a method in which high-power computers conduct trading under a few instructions. These instructions are conducted through a complex algorithm at a very high speed.
This is why algorithmic traders have a higher turnover than those doing it manually. This is the reason why algorithmic trading has a higher trading ratio.
Let’s discuss another major benefits of algorithmic trading. As we all know, algorithmic trading involves high-power computers, which means less human invention; this is why algorithmic trading has reduced human errors.
However, trading done by a human can have problems in analyzing, which causes technical indications, but computers completely control algorithmic trading, so this can easily avoid discrepancies like these.
Trading can either make a lot of gains or cause excessive losses, so traders who don’t want to lose their money should find their trading system flawed and make possible changes.
In algorithmic trading, there is a lesser chance of loss because this system provides backtest opportunities for traders to use their historical data and compare them with their recent data.
Lower Transaction Cost
Lower transaction cost is another benefits of algorithmic trading. Algorithmic trading doesn’t ask to be monitored by the trader constantly which easily reduce a lot of transaction cost. The algorithmic computers already have a set program that monitors trading activities, so there is no need for a supervisor.
Capacity To Quickly Execute Several Trades
In algorithmic trading, you can easily carry multiple trades simultaneously and don’t want to worry about any of them. As we all know, all trades are easily monitored through computers; this means you can have multiple trades and increase your earning capacity.
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How Does Algorithmic Trading Work?
To understand better how algorithmic trading work, let’s take an example in which a specific trading criterion is followed by traders, which is given below:
- A trader by a stock having 50- a day moving average has already crossed the 200-day moving average.
- The trader will sell its stock when the 50-day moving average falls below the 200-day moving average.
Usually, in a manual trading system, a trader has to put the stock price manually when they have to exit or enter the trading platform. Now it’s time for the computer to do its work automatically, in which it will watch the stock price and moving average indicators.
By only using two simple commands computer will automatically buy and sell orders according to the preset circumstances. Now traders don’t need to enter orders and check the prices and graphs manually.
This will automatically be done by the computers, which are called algorithmic trading systems that best detect a trading opportunity.
Drawbacks of Algorithmic trading:
As we all know about this online trading strategy in which trading is completely under computer control, you will need highly powerful computers with a strong internet system.
In case of any issue in the internet connection system, it can completely cause a failure of the executive trade, causing large losses.
Additionally, in the algorithmic trading system, the trader will need high and complex technology, which is high in cost. So maybe for many traders to pay that much cash for such services. In another case, to use the algorithmic trading system, a trader will need expertise, and if he doesn’t have it can cause an immediate loss.
The automatic trading system can cause a lot of manipulation in which artificial demand or supply in the market can be created by malfunctioning algos.
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Basic Strategies Of Algorithmic Trading:
In algorithmic trading, many strategies are essential to learning before you get involved in this automatic trading system. Here are some of the basic strategies:
1. Momentum strategy
Momentum trading is a basic trading system in which different companies and traders buy or invest in stocks with increasing value. And later, they sell it when they feel the stock value can fall.
This strategy use market volatility which ends up making huge returns. In easy words, the traders using this strategy will buy short-term uptrends, and in the future, they will sell it when the price starts to fall.
2. Mean reversion strategy
It is hard to sustain the extremely moving trading price for a long period which causes average price returns. The traders who partake in mean reversion have easily used different trading methods to capitalize on the theory.
There are different extreme levels like volatility, price, growth or technical signal on which a bet is placed by predicting that these will revert to normal. On average or normal level, these asset prices revert, which is called the reversion technique.
3. Sentiment – Based strategy
In this strategy, different positions are driven by bulls and bears. During the optimism in the market, it is a strong belief that the market value or asset will surely increase.
Is It Safe To Do Algorithmic Trading?
Algorithmic trading is the safest trading system. In human trading, there is a high chance of errors in the variables, which causes a high risk of mistakes and traders losing a lot of money.
There are powerful computers utilizing the algorithm to perform and monitor the trades, which means less human involvement. Hence algorithmic trading provides security to their traders. However, in the trading market, traders and investors have different views about algorithmic trading.
Before you finally decide to invest using an algorithmic trading system, learn it properly because it’s not a lottery, so you have to take time to master it.
How To Build An Algorithmic Trading System:
There are a few simple steps to build the algorithmic trading system. But you need to understand types of algo trading and algo trading strategies first. You can also seek help from algorithmic trading pdf books. Once you have finalized the best algo trading strategy, you can follow the following steps.
1. Make Sure To Differentiate Between Equities And Future
The first thing you must do is understand the proper difference between equities and the future. You are not investing in a corporate entity when you trade in futures.
Instead, you are investing in the contract to gain exposure to different tangible assets, including coffee, oil, soybeans, corn or many other commodities.
It covers all the stocks, bonds, currencies, and even weather in future contracts.
2. Working With A Trading System
So after learning the main difference between equity and the future, it’s time to learn about the hypothesis-building system.
There are two main steps of the hypothesis, which involve;
- First, you should know the preparation and building of data.
- Secondly, you should have good quality data having length and data with corporate action adjusted.
Algorithmic trading: Is it legal to do so:
Yes, it’s completely legal to follow the algorithmic trading system. No specific rules or laws can limit the use of the algorithmic trading system.
Indeed, a few traders may think that an algorithmic trading system is creating an unfair trading environment that adversely impacts the market. However, it’s completely legal to use an algorithmic trading system.
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Bonus: Avoiding Algorithmic Trading Scams
When you are going to use a trading system, that sounds good and probably is. It will still have some scams found around it. Here are a few tips that will help you stay safe while trading.
- Always scrutinize everything before paying. Because in case of not doing it, you can lose your money.
- Do detailed research before investing, and always read all the terms and conditions before committing.
- Check the third-party sites to read all the testimonials.
- Many scams don’t have a trial system, so make sure to look for a trial system first.
In this article, we have covered everything about algorithmic trading and all the benefits of algorithmic trading. Undoubtedly, it is the automatic trading system controlled completely by the high power computers. But when trading, have a strong command of algorithmic trading systems. And you will end up making a lot of profit. You can learn more from algo trading strategies pdf books.
Is algo trading profitable?
Undoubtedly, algorithmic trading is very profitable because it helps you do different things correctly.
These things include proper backtesting and validation ls help you correct all your risk management techniques.
What are the goals of algorithmic trading?
Algorithmic trading isn’t only about making profitable traded, but you can also save a lot of costs, minimize the market impact and execute all the risks of trading orders. This helps the traders not to monitor any stock; everything will be done automatically.