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What is Algo Trading In The Stock Market? Learn The Basics and How It Affects Stocks

So you’ve come here wondering, “What is Algo Trading In The Stock Market?”

And this is a great question because, algorithmic trading in the stock market has changed stock market trading incredibly over the past number of years.

And in this article, we’re going to investigate exactly what’s involved.

We’re going to cover the following topics:

What is Algo Trading in the Stock Market?

Algorithmic trading, or algo trading for short, is when traders implement their strategies through computers. What this means in practice differs per individual strategy. Some have argued that algorithmic trading has caused greater market instability, while others have said it is what has made our current bull market possible.

Algo trading or algorithmic trading is a technique for performing orders and tasks using automated pre-programmed trading rules & instructions that account for variables such as time, price, and volume.

As we know that computers have revolutionized the world through its speed and accurate information handling, a need for speeding up the trading process also aroused. So, the computers were integrated with the trading industry so that it can also benefit from all the advantages that the computer provides. This usage of computer in trading created the algo trading. In this article, we will answer the question that everyone has in their minds, “What is Algo Trading in Stock Market”? Some popular and most widely used examples of algorithms are the percentage of volume, Pegged, VWAP, TWAP, implementation shortfall, and target close. The algo traders use the high-frequency technology that enables a firm to handle thousands of trades per second. Investment banks, mutual funds, pension funds & hedge funds are making the most use of algo trading. A research made in 2016 concluded that almost over 80% of the trading in the FOREX market was done by trading algorithms instead of human beings. This shows it’s rising popularity. The terms algorithmic trading & automated trading are used interchangeably. Algo trading can play a vital role in completing tasks like the execution of the order, arbitrage, and trend strategies. Its popularity has been growing since the 1980s.

What are the benefits of using an algorithm in stock trading?

There are many different advantages that come with using an algorithm in stock trading. Here are a few of the most common ones that people experience, but it’s important to note that this will vary depending on what type of algorithm you’re using.

  1. Helps reduce the amount of time spent manually entering data by providing constant updates on every transaction happening on stocks.
  2. Allows for increased accuracy when looking at potential investments because it can take into account tons of variables to help understand how the market may respond later down the road.
  3. It’s also adaptive which means it adjusts based off changes happening in real-time so you’ll see more security and better predictions during volatile economic times!

How does Algo Trading Work?

Before getting into the detailed description of how algo trading works, we will take discuss a little bit about algorithms. An algorithm is a step by step plan devised to solve a problem. The working of algo trading depends upon computer programs. Computer programs enhance trading by improving the speed and efficiency based on the stock prices and the current conditions of the market. The following example will help you understand the working of algo trading in more detail. Suppose that a trader buys 50 shares of a company when the 50-day moving average gets above then the 200-day moving average. This shows that stock prices will rise very soon. And when the average goes below the 200-day moving average, the buyer sells the stock so he can prevent himself from any monetary damage. That is how a trader works in traditional trading. But the algorithm to execute orders when the price of the stock goes above and beyond the average moving value of 200-days or a specific price. Based on the conditions, the computer program can itself decide the number of shares to buy. With algo trading present in the game, the trader only has to start the program, and then all he has to do is to sit back and enjoy the show. The algorithm will take care of everything itself. The AI-powered algorithms have changed the face of the market completely.

Algorithmic trading is a strategy that uses pre-programmed algorithms to execute the buy and sell orders. Unlike traditional stockbrokers, Algorithmic traders can work full-time and generate profits 24/7, only limited by the frequency with which strategies need to be updated.

A trader will write an algorithm with various inputs such as time horizon of investment, total market exposure desired (as a percentage), number of trades per day or as needed, trigger price for entry or exit as well as either go long or short on market trades. When those conditions are met, the algorithm will execute its trade automatically.

Algorithms can often perform better than humans due to their ability to quickly analyze massive amounts of information.

Is it Beneficial?

As we are discussing the question “what is algo trading in the stock market” I don’t think that the answer can complete without discussing its benefits. Algo trading has brought a lot of perks with itself in the field of trading. In the following, we will discuss how algo trading can be beneficial.

1) Backtests Dependent:

For an algo trader, guessing is no longer a part of the game. Now, historical backtests are used to judge the performance of trading strategies. Backtests can also help traders estimate the average winning and losing amount.

2) Computer is behind every execution:

Computers gave a big relief to traders as it executes all the strategies. A very big drawback of technical trading is that the traders cannot maintain their focus for a long time. This losing of focus results in errors. But this problem has been solved by algo trading. Although computers can make mistakes but with the help of a little monitoring, you can overcome this problem.

3) It’s no longer an emotions game:

It is very difficult for human beings to get rid of the greed emotions and fear of losing. These two factors can destroy the quality of trading. This is where a computer comes in handy. As computers don’t have any emotions, there is no possibility of making an emotional mistake. In the computer world, the instructions are executed only if a certain criterion is met. This virtue of computers can save you from a lot of troubles and can also help in improving your decision-making power.

4) Computers never go to sleep:

Just like a military soldier, who is always waking up to defend the borders of his motherland, a computer is also always waking up to solve your problems. In algorithmic trading, the strategies are executed as long as the market and stock exchange is open. This is a very big problem in traditional trading. The traders miss important opportunities due to sleep and being away from the internet connection. But algo trading has given the solution for this trouble and this long is an area of concern.

The Advantages of using these types of tools for stock trading

We’ve already touched on a few of the advantages and huge opportunity available on how you can automate your stock trading, but here are a few more:

  • Reduces latency/increases speed, allowing traders to get their transactions done quickly.
  • Reduces mistakes through repetition.
  • Will usually beat manual trading in terms of profitability over time if designed well.
  • Can correct for “emotional” behavior seen with many professional traders.
  • Provides unprecedented access to allow new participants to get involved.

The Drawbacks of this kind of trading

Of course, there are drawbacks to this sort of investing as well.

  • Less human intuition (although this can be both good and bad)
  • Requires more capital than manual trading
  • Rarely takes emotions into account
  • High chance of losing money or taking a loss if it’s done wrong
  • Relies on massive amounts of data as Artificial intelligence algorithms require huge computing power

What are Algorithmic Trading Strategies?

Now, we will talk about some of the best algo trading strategies.

➢   Trend-Following Strategies:

Trend-Following strategies are the easiest and simplest strategies. This algo trading strategy follows trends like moving averages and channel breakouts. The reason why these strategies are so simple is that they don’t require any involvement of predictions or price forecasts. In these strategies, algorithms are used to evaluate unique patterns to execute trades once the electronic indicator conditions are met. 50-day and 200-day moving averages are a popular example of trend-following strategies.

➢   Arbitrage:

This strategy is used when the price varies in different markets. You can buy stock from one market at a lower price and then sell it on another market at a higher price. This strategy is used for making profits based on the market price.

➢   Mathematics-Based Strategies:

Mathematical models like the delta-neutral strategy have proved to be a very efficient algo trading strategy. In this strategy, trading is performed based on a combination of different options.

➢   Mean Reversion:

When a stock experiences a jump in price, it is assumed by the traders that the stock price will return to low again. This strategy is known as mean reversion.

➢   Volume-Weighted Average Price:

Volume-Weighted Average Price or VWAP is a strategy that involves the disintegration of a large order into small portions using stock-specific historical volume profiles.

➢   Scalping:

Many traders have the wrong perception that scalping is not a good thing and is not beneficial. But in reality, this perception is wrong. Rather, scalping enables you to make greater and significant profits. Scalping is different from all other trading strategies. It depends on the difference between the asking price and bid of security. The scalping aims to make a considerable impact on the market. Scalping can be a complicated and tricky strategy. And it surely is not for the amateurs and beginners.

Is algo trading profitable?

Yes. Algorithmic trading is generally profitable, with the computer automatically initiating orders in fractions of a second without human intervention. This form of trade can be used aggressively to generate income by identifying low-risk/high reward situations and attempting to profit from them consistently over time or it can be used risk-analytically for hedging purposes where it identifies high-risk situations that require some measure of protection.

Is algo trading the future?

Yes. Major firms are reducing their dependence on traders because algorithmic trades are nearly always more profitable even when account costs are taken into consideration.

That said, the profitability of algo trading is dependent of the strategy and trade instructions given to the computer program.

But all major firms increasingly use at least some form of algo trading in their systems, and there are even algo trading programs that are available to individual investors such as trade-ideas.com.

Is algorithmic trading easy?

Yes. Once you have your strategy, it’s just a simple matter of coding the program.

If you have the tech skills, you can do this yourself or you can outsource it.

Most traders use ready made trading programs or subscribe to something like trade-ideas.com in order to use the power of AI in their trading.

Once the program is set up, the computer does all of the hard work for you.

How to learn Algo Trading online?

Learning algo trading is not a difficult task. There are several resources available online. Many courses are available on different platforms like Coursera and Udemy. Investmental management with python and machine learning, machine learning for trading, and Financial Engineering and Risk Management are some popular algo trading courses and specializations available on Coursera.

How you can get involved with DIY Algo Trading

You can get started by learning how to code your own algo-trading robot.

To get started, you can take the following steps:

1. Determine the stocks you’re interested in trading. Begin with broad trades like health care, energy, or technology to get acquainted with how they work and if this is even right for you.

2. Do your research on what analytical methods investors are using to trade these particular products/industries so that you can build algorithms based on market sentiment. If no one has built analytics around a specific company within your industry of choice, it might be worth looking at potential areas that others haven’t yet analyzed or researched; new markets will inevitably need analytical tools created to appropriately predict future movements in price over time (so create some yourself!)

3. Start small–it’s an art form like anything else! Make sure you backest your strategy and then start trading really small positions.

If this seems too difficult for you (or you don’t have the programming skills), you may want to consider getting trade alerts sent to you by joining The Empirical Collective, or signing up with trade-ideas.com

Why is the stock market so high?

Algorithmic Trading has been the source of debate for multiple reasons. Some people say that algorithmic trading (sometimes referred to as “high frequency”) has increased market volatility (resulting in the occasional flash crash), while others have said that it has helped fuel higher stock prices. Others have complained that they have been pushed away from being able to trade because of HFTs. There have also been attempts at creating a “passive” investment product, such as ETFs and Low-Frequency Funds , but these products typically get beaten by index funds or other low cost options over time due to fees.

Computer trading for the Average Investor: Trade-Ideas.com

Trade-Ideas.com is a stock idea generator that offers a service to scan for ideas without requiring substantial time input from traders.

It’s a pretty unique approach for individual traders looking to take advantage of predefined trade options and filter market data to trade their portfolio.

Trade-Ideas scans the market to create a list of potentially good investments, but not so many as would overwhelm you with data. The company also runs reports on stocks and other investment vehicles often to get feedback from seasoned investors who have been successful in the past.

Their trading software filters stocks based on certain trading strategies to spot stocks that are ready to increase in value, but you can also program it filter stocks based on your own specific or defined trading strategy.

You can find more information on their program here.

Quants: What They Do and How They’ve Evolved

Quantitative trading is a strategy that uses mathematical formulas and computer algorithms to automatically execute trades in the financial markets. Quantitative traders rely on computers and technical analysis rather than intuition to understand market conditions.

Equity quant strategies include arbitrage, statistical arbitrage, index arbitrage, merger arb (arbitrage) and event-driven strategies.

Within fixed income quant strategies we find credit product-centered strategies including CDS (default swaps), CDO (collateralized debt obligations), corporate actions like put writes and call writes. For derivatives traders we will typically find interest rate quant traders spanning from Interest Rate Swaps (IRS) to Forward Rate Agreements (FRAs).

Conclusion

In this article, we discussed algo trading. We tried to answer the question “What is algo trading in stock market”? This is a question that every newbie has but they never get an answer that can satisfy them. I hope that all the details we have discussed were able to create a sense of comfortability in your minds and your way to starting doing algo trading is now clear and there are no more hurdles in your way. First, we talked about what is algo trading then we discussed its working. After that, we discussed the ways algo trading can benefit you. And then later in the article, we talked about the platforms from where you can learn algo trading online, and then finally we told you about some popular and simple algorithm trading strategies which work. Trade-ideas.com is a software which can be helpful for people who are willing to use the algo trading. Now the only thing stopping you from doing algo trading is your fear. So, eliminate that fear and dive right into the world of algo trading. Good luck!