Rapid growth toward automation and digitization has brought about a sea change in the financial markets. The volatility of the high-speed stock market has augmented the mathematics and strategies of the finest traders. The technology-driven stock markets now call for an emotion-free advanced trading system to grasp every single market change within seconds.
Algorithmic trading or Algo trading, as it is generally referred to, is the newly emergent trading concept that is driven by technologies such as artificial intelligence and machine learning, and seems to be adept at beating the market fluctuations to gain potentially high returns for investment funds.
This article covers:
- What is Algorithmic trading?
- Features of Algo trading
- How to create an account for Algo trading?
- Eligibility for investors to avail an Algo trading service
- How does Algo trading work?
- Companies involved in Algo-based trading
- Advantages of Algo trading
- Risks and limitations involved in Algo trading
What is Algorithmic trading?
Algo trading is an advanced automated stock market trading system that needs computerized instructions (program or algorithm) instead of human commands to carry out market functions.
In this kind of trading, a computerized set of instructions or an Algorithm is designed to trade in the market to buy, hold, or sell the securities at a right time. This is primarily to leverage the system’s speed and error-free calculations against dependence on a human mind. Traders also refer to such automated buy/sell programs as black-box trading.
Algo trading system proves to be a solution for investors who are extremely risk-averse or do not wish to participate in market fluctuations. Following are some salient features of an Algorithm trading mechanism.
Features of Algo trading system
Fully automated trading system
Unlike other online training systems, it employs an automated instruction package to place an order. Trading platforms offer a wide range of order packages that enable traders to earn good returns with the most negligible risk.
Wide range of markets and instruments
Digital Algo trading platforms offer a variety of instruments and markets that a trader can pick and trade-in.
Traditional trading with brokers requires a manual strategy to buy, hold, or take a position. Also, intra-day trading demands a consistent watch of the market. But with this system and tech software, the entire process of trading can be automated requiring no third-party interventions.
How to create an account for Algo trading?
In India, numerous companies are now offering Algorithmic trading software. Desired traders utilize the techno-based trading services from these companies. Like a Demat account, Algo trading service companies also ask the investors to start their venture through an account.
Algo trading with these brokerage firms can be availed through a simple Demat account. However, some highly specialized professional Algo traders create a separate account for you that follows some simple steps:
- Firstly, it demands to fill an email and password to secure the validity.
- After setting a strong password and providing required documents, it may demand some additional information regarding occupation, annual income, savings, and investment.
- If you satisfy the investment limits the trader allows you to open an account.
- Opening an account could also ask for additional details like triaging experience in stocks, F&Os, and other derivatives.
Eligibility for investors to avail of the Algo trading service
Algo trading cannot be used by every investor. Even trading companies prefer to provide personal trading services to high net worth investors and institutional investors.
Algo trading companies set a variety of parameters and fund ranges to onboard investors. Once investors meet the set criteria, the company promises to set up, for each investor a robust and tailor-made investment strategy.
How does Algo trading work?
Like the human mind strategizes to place a perfect time and value order, AI-based algorithms claim to provide a better time-value return, free from human bias and errors, in a high-speed frequency market.
Generally, traders use machine learning with artificial intelligence. This starts with specific rules-based programming in the Algo program. The rules help the computer pick up nuances of the current market changes and make quick decisions accordingly.
Traders follow the following mechanism under this type of trading:
Data filling and input in the system
The first step is to collect data in order value, desired time to place an order, required conditions for positions, and other relevant information.
For example, you want to set a code for an order after 10 days with the condition that you will purchase 100 shares in case the index value crosses 50,000 points. In this order, required input would be time for the trade, condition for indices, value of trade, number of shares that is 100 shares (in this case), and other refined rules.
Creation of a code or Algorithms
In simple words, an Algorithm is a set of multiple instructions or constraints regarding order conditions. A trader may use a software language like C++, Java, Python, or an artificial neural language based on order requirement, time, value, and frequency.
With a selected language, traders create a code with pre-defined data and rules. With the testing process, rules and conditions can be added or removed to get a robust result.
Execution of trading strategy created with Algorithms
The final step of the mechanism is the accomplishment of creating an AI-based trading strategy. As per the condition filled, an automated system executes the order with market trends. It does not have a human sentiment trait which in turn facilitates a free implementation of coded strategy at the perfect time.
This automation-motivated trading system ensures a better return performance and henceforth have made it easy for large fund investors and retail participants to trade in complex high-speed markets.
Companies involved in Algo-based trading
Algo service-providing brokerage houses are brokers and financial firms with advanced technological coding systems and analysts. These systems and brokerages use a set of specific criteria for trading.
Following skills and qualities are primary to offer to trade on behalf of investors:
- High-technological and machine learning system.
- Human capital with strong quantitative and data science skills.
- Fast computing technology with financial constraints.
- Sound analysts’ base for making robust strategies.
With these essential prerequisites, a trading can brokerage firm can offer tech-driven Algorithmic trading.
Advantages of Algo trading
Trading with technology-based Algo trading can enable you to outperform the market with a highly efficient coded strategy. Due to sentiment-free decision-making, traders can extract the maximum out of a trade deal. Following are the other advantages:
High range of efficient software
Trading firms use numerous software to complete an entire trade deal. Some valuable softwares are Pro Realtime, Native APIs, and Meta Trader4.
Adoption of a wide range of instruments and market
In order to place a perfect order, programs can reach any market instruments within any market like a bond, stock, or derivative market. You can create any trading strategy to earn the best possible return.
Ensures better investment return for high investments
Generally, Algo trading is used by high net worth investors due to the large funds invested in the stock market. It assists with efficiently applied techniques in order to set fine-tuned market orders.
Risks and limitations involved in Algo trading
Trading, even with an Algo-based system, includes some risks and issues:
Risk of faulty coding
Algorithms that are coded by the human mind run the risk of faulty codes. A single discrepancy can potentially destroy an investor’s fund.
Markets that are characterized by volatility may not find Algo trading very profitable. In case of a sudden spike or fall, the system can run haywire, reducing returns.
Require a proper set of instructions
To run a proper function, pre-defined conditions are required as input in the system. Single misinformation could result in faulty programs and wrong order placements.
Pure automated based system
No doubt, a computerized trading system is much more effective than traditional decision-making. However, computer software is not designed to digest sudden rise/fall or events that impact the markets.
The fast-changing stock market has generated a need to have an automated trading system free from human biases and errors. Algo trading is an alternative solution for investors, especially high net individuals as it can help provide larger returns through computerized codes and trading strategies.
But it is to be remembered that such systems come with their own complications and cannot change strategies in a nick of time like humans. But this must not refrain an investor from choosing Algo trading.