Algorithmic trading is a trading system that operates on a very advanced mathematical models for making transaction decisions in the financial markets by following a set of predefined instructions so as to generate profits at a speed and high frequency that is impossible for a human trader. The strict rules built into the model attempt to confirm the right time for an order to be executed that will cause the least amount of impact on a stock’s price. Algorithmic trading is most commonly used by large institutional investors as they purchase a large amount of shares every day. Complex algorithms allow these investors to obtain the best possible price without significantly affecting the stock’s price. Trades get executed at the best possible prices in Algo trading. They happen to be instant and accurate to avoid significant price changes. It leads to reduced transaction costs and risk of manual errors in placing the trades
The greatest portion of present day algo-trading comes from high frequency trading (HFT),
To undertake algorithmic Trading, one needs to have the following:
- Computer programming knowledge to program the required trading strategy
- Network connectivity and access to trading platforms for placing the orders
- Access to market data feeds that will be monitored by the algorithm for opportunities to place orders
- The ability and infrastructure to back test the system once built, before it goes live on real markets
- Available historical data for back testing
However, the practice of algorithmic trading is not that easy to maintain and execute. Prices fluctuate in milli- and even microsecond. If you do not manage it well, you will end up sitting with an open position, making your arbitrage strategy worthless. Additional risks like system failure risks, network connectivity errors, time-lags between trade orders and execution, and, most important of all, imperfect algorithms also make it to the list.
One must make sure the system is thoroughly tested and required limits are set. Analytical traders should learn programming and building systems on their own and be confident about implementing the right strategies in foolproof manner. Cautious use and thorough testing of algo-trading can create avenue of infinite profits.
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11 Comments. Leave new
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