In this age of super computers, Algorithmic Trading has gained a huge popularity from last decade. In the United States, around 70% of total Trading volumes comes from Algorithmic Trading. In developing nations like India, it accounts for around 40% of Trading volumes, not a bad number anyways! Retail traders tend to keep away from Algorithmic Trading considering it complex and out of reach. However, it’s not true at all. Building an Algorithmic Trading system can be a simple task if one knows the fundamentals behind it. This article intends to introduce Algorithmic Trading concepts and would outline its benefits as compared to manual trading. There would be a follow-up article very soon to help you build an Algorithmic Trading system from scratch.
What is Algorithmic Trading?
Algorithmic Trading is a process to Buy or Sell a security based on some pre-defined set of rules which are backtested on Historical data. These rules can be based on Technical Analysis, charts, indicators or even Stock fundamentals. For example, suppose you have a trading plan that you would Buy a particular stock if it closes in Red for 5 consecutive days. You can formulate this rule into Algorithmic Trading system and even automate it so that Buy order is placed automatically when your condition is met. You may even define your stoploss, target and position sizing in the algorithm which would make your Trading life easier.
Algorithmic Trading Benefits
It’s said that your success in Trading depends on 30% market analysis, 30% risk management, 30% emotion control and 10% luck. If we keep luck aside, then Algorithmic systems can take care of rest 90%. Most of the Traders fail when emotions intervene in their trading decisions. Even the seasoned traders panic while pressing Buy/Sell button which eventually leads to loss. Also,Traders tend to ignore stoploss or book profits early which is again a drawback of manual trading. Algorithmic systems will take care of all these drawbacks associated with manual trading. Also,if you are busy with your day job and cannot devote time to trading, then you can simply automate your algorithm so that your computer can trade on behalf of you.
Algorithmic Trading vs Manual Trading
Below comparison table would clearly explain the differences between Algorithmic and Manual Trading:
|Manual Trading||Algorithmic Trading|
|Involves human emotions||Free of emotions|
|No pre-defined rules for Buy/Sell||Rules are pre-defined and backtested|
|Need to monitor the market all the time||No need for continuous monitoring of market if you have automated your algorithm|
|Risk management imperative to avoid big loss||Risk management is a part of Algorithm|
|No validity of success as your Trading rules may differ in each execution.||Every algorithmic system is backtested on Historical data.Hence the probability of success increases|
|May lead to heavy slippages||Trades are placed at pre-defined levels governed by Algorithm. So slippage reduces considerably.|
Is Algorithmic and Automated trading similar?
This is the most common misconception associated with Algorithmic Trading. Algorithmic and Automated trading are not same. You always have an option to automate your Algorithmic strategy but it is not necessary. You can even trade manually through the signals generated through your Algorithmic system. In order to automate your Algorithmic strategy you have to get an exchange approval for your algorithm. But that is not a difficult process until your algorithm is error free. So next time whenever you come across an Algorithmic Trading system, just have a look whether it is automated or manual.
Algorithmic Trading Examples
We have a section devoted in our website for Algorithmic Trading setups. These setups are either built on Amibroker or Excel sheet. Please refer the below links for the same:
Algorithmic Trading Myths
Below are some of the most common myths associated with Algorithmic Trading:
Algorithmic Trading is complex and requires deep mathematical and statistical knowledge
No, it’s not. You can even convert your simple trading rules into Algorithms and trade through it.
Algorithmic Trading requires huge capital
No! You can even buy very small quantities using Algorithmic Trading.
Algorithmic Trading is not for retail traders
It is for everyone. Just in case you want to automate your algorithm you would need dealer terminal from exchange
Algorithmic Trading requires super fast computers and infrastructure
This may be required only if you are doing high-frequency trading using algorithms. For anything else your PC is sufficient.
Algorithmic Trading and Automated Trading are same
Not at all. Algorithmic trading can be done manually too.
Check out the below link to get started with developing your own Algorithmic Trading system: