A journey of a thousand miles begins with a single step. Well, that is the story of a trader who is afraid to enter the world of algo-trading. Since the eighteenth century, technology has evolved continuously. Today, it has changed the way you trade and manage your investments. A trader who has good exposure to the stock market often considers improving their trading strategy with technology. The tech has empirical value in the modernisation of traditional trading to algo-trading.
The use of this technology is crucial to calculate and achieve profitable results. It is used to automate the electronic device for one or multiple trading strategy executions. It is different from its goal and has the ability to test different mathematical models with the real stock price in the system. The main objective of algo-trading is to make high-speed trading possible without any errors or delays.
The use of this technology is crucial to calculate and achieve profitable results. Algorithmic trading can be used by either institutional investors or large brokerage companies. It provides high-frequency trading to professionals from banks, mutual funds, and hedge funds. Unlike human managers, who have high recurring costs, algo-trading software has a one-time cost. Other companies that make use of the algorithmic trading system are:
- Investment funds
- Investment banks
- Brokerage service
- Retail investor
- Sub-broker
- Discount broker
Table of Contents
How Does Algo-Trading Work?
Algorithmic trading is a process of instructing trade orders through a capable system that is connected to the Internet. This system is set up or pre-programmed as automated trading commands to account for individual factors such as volume, time, and the price of the equity. This algorithm works in such a way that it follows a set of instructions to solve a problem related to the trading scenario.
As a result, slicing these complex problems helps traders achieve higher returns. The reduction of human interference, along with the capability of computers, makes it super fast to make significant amounts of trade. Algorithmic trading can be utilised in several scenarios, such as trend strategies, moving averages, arbitrage, intraday trading, and scalping. An algo-trading system’s goal is to save money, reduce error, and execute trades without the need for constant monitoring of the system.
Types of Algo-Trading
Algo trading is used in multiple types of trading. You can read about these strategies in the sections below.
Arbitrage Trading
In this type of trading, an investor makes a profit from small market price differences of the financial asset trading on different exchanges, where the financial asset’s value on one exchange is lower than the other, and vice-versa.
Pairs Trading
In pair trading, the market-neutral technique allows traders to benefit from short differences in the relative value of similar substitutes. Here, you can apply this technique to individual equities.
Mean Reversion
It is a mathematical approach where investing in stocks is done by determining the stock price range and then calculating the average price by using the analytical approaches relevant to the assets, earnings, and other factors.
Trend-Following
In the trend-following approach, we can use the trading model to predict the future trend by analysing the present and past data of a stock price.
Delta-neutral Strategy
The delta-neutral refers to portfolio-linked assets where you can see that the portfolio is unaffected by the minor changes in the underlying assets. In these strategies, the portfolio is generally offset, and the relative value of trade is unaffected by any minor movement of financial assets.
Scalping
In the scalping trade, the trade is done multiple times over a single trading day, and the timeframe of this trade is seconds or microseconds. In this trade, the time and the stock price difference is quite important. It’s hard for human traders to track and make such quick trade executions, so to crack this problem, algo-trading software comes into place.
Rise of Algo-Trading
Algorithmic trading is used to employ strategies and carry out trades. This trade is based on the conditions it holds. It can be used for the following occasions:
- When large firms and institutional traders use algorithms for various purposes.
- It has low costs in trading and maintenance.
- The popularity of the foreign exchange algo market has spread to the Indian stock market.
- It has high popularity among the new age traders who are skilled with the latest technology.
- There are fewer errors and better testing for the algorithm trading model.
Algorithmic trading facilities are growing and improving day by day. Traders are relying on this type of trading, which has made trading easy and affordable. Instead of a human manager managing a few handfuls of portfolios, algo-trading can handle hundreds of portfolios with ease, and the cost of trading is calculated and reduced for the benefit of the investor. One more advantage of algo-trading is that the liquidation rate is high in these trades due to the speed of the algo-trade.
