Algorithmic Trading 101

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

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:

Amibroker Trading Systems

Excel Based Trading Systems

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:

Build your own Algorithmic Trading System: Step by Step Tutorial

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  1. It is like you are doing social help to those people who are losing money doing manual trading. Keep it .

  2. But what is the best Robot strategy? Nobody seems to want to tough this! If one strategy had a proven track record, it would be all over the news. I am skeptical about robots for retail traders. Trust me, I am actively trying to build a robot too!!

    • Hi David,

      There is nothing ‘best’, it all depends on the market and stocks you are trading. A strategy that works on one instrument may not work on the other. Also, any strategy can’t work forever. You just need to play around with different strategies and pick the one which is relatively better than others

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