Trading can be done in many ways. But if you make the most of strong and efficient algorithms, then you can see some serious gains. That is what trading with algorithmic trading is all about. So, what is it?
Algorithmic trading is trading with the help of a computer-based algorithm on a specific set of instructions. And the system will only execute a trade only when the specific instructions are satisfied.
There are a lot of things that you need to consider when doing algorithmic trading though. There is the quality of the algorithm itself and the software. A particularly important debate is about whether you buy the software or build one.
What is Algorithmic Trading?
Before I define exactly what algorithmic trading is, you need to first understand what an algorithm is. The word might sound very tough and technical. But in reality, an algorithm is only just a set of instructions defined for a computer program to solve a problem.
So, that means algorithmic trading is a type of trading that uses a computer program with a specific algorithm defined for trading. That is why this type of trading is also called automatic trading – for obvious reasons.
Here is the thing, the algorithm can be quite complex and may have a lot of parameters as well. The instructions as they are can be defined based on multiple things. It can be defined based on the quantity, pricing, or a mathematical model as well.
The good thing about automatic or algorithmic trading is that it takes the human emotion out of the picture, somewhat. And what you end up with is more liquid and systematic. It also creates profit opportunities for the trader! That is the goal in the first place.
What Are the Benefits of Algorithmic Trading?
So, why do traders even use algorithmic trading? Well, some benefits are quite hard to ignore.
And if you are a trader that is using their own hard-earned money to buy and sell shares and stocks, you want all the advantages you can get. Here are some of the benefits of algorithmic trading:
- Trades result in the best price. Ordering is also accurate and instant.
- Price changes can be avoided by timing trade instantly.
- Automated checking on multiple market conditions.
- Less manual errors in general when placing new trades.
- Backtesting can be done to check for viable trading strategies by using historical data and even real-time data.
How Algorithmic Trading Works?
As I mentioned, the algorithm will use a set of instructions to buy and sell stocks. The instructions can be given to be anything. Let’s use an example in this case for understanding how it all works.
Say a trader instructs that a stock should only be bought when the 50-day moving average climbs above the 200-day moving average. And when the opposite happens, the instruction is to sell the stocks. That means when the 200-moving average dips below the 50-day moving average.
When these instructions are given to the computer, it will automatically monitor the stock price. That means you, the investor, do not need to keep your eye on the live prices. It will buy and sell stocks only when the appropriate conditions are met.
You do not need to put in orders manually either. This is where automation comes in. It identifies the trading opportunities and takes action accordingly.
Prerequisites of Algorithmic Trading
Since algorithmic trading uses computers to a heavy extent, you need some technical competencies. However, that is not to say that you cannot do algorithmic trading without any kind of these skills.
You can also hire someone else with the right expertise to help you through the process. Here are some of the technical skills that will make things easier:
This one is a bit obvious. Computer programming knowledge to help program and create the specific algorithm is important. But as I already said, you can still work with algorithmic trading without having programming knowledge.
You can use an existing algorithm or hire someone to write the program and algorithm for you. Both are pretty viable options.
Without network connectivity, your brand spanking algorithm will not do you much good. It is like having a super-fast car engine without tires. Network connectivity along with access to trading platforms will allow you to make orders.
Access To Historical Data and Market Data Feeds
Available historical data will help you with backsetting. It will, of course, depend on the complexity of the algorithm though. The algorithm also needs to monitor the market data feeds. So, access to that is very important too!
How to Pick the Right Algorithmic Software?
Before wrapping up, let’s look at something you need to keep in mind when choosing the right software for algorithmic trading. I will keep this one short. So, do not worry.
There are a couple of things you need to consider. However, sometimes you might want to buy the software or build one from the ground up. Both have their upsides and downsides. Purchasing software definitely gives you the benefit of instant access.
You do not need to wait for weeks or even months for your software team to build one from scratch. There are many tried and tested software that already exist in the market. But there is a cost involved. They cost quite a hefty price and also maybe have some loopholes.
If you ignore these, that can cause you losses. The high cost of software can eat into profits. However, building one from the ground up takes a lot of technical expertise. Not to mention time and also hiring of technical staff and engineers. But then again it might not be completely foolproof. If you are thinking of buying one, then here are the features you need to check for:
- Availability or market/company data
- Market connectivity
- Lowest latency
- Trading interface integration
- Plug-n-play integration
- Platform independent base or programming
- Ability to write custom programs
With the right algorithm and system, trading with algorithm trading will become much more efficient. You can free up time for yourself and work on other important stuff. However, algorithm trading is not autopilot for buying stocks and shares. You still need to set parameters and the right instructions.