Algorithmic trading is a trading method that uses computer codes and chart analysis to enter and exit trades according to set parameters such as price movements or volatility levels. Trading on algo platforms is gaining traction among traders and investors as it involves less manual execution and more technology use.
Trading algorithms match the current market conditions with any predetermined criteria to execute a buy or sell on your behalf. Is it effective in scanning the markets? Yes. And how?
Algo trading prioritises technology and software based on predefined methods and has the minimum human involvement, thereby eliminating the risk of errors. Algo trading is widely used by investment banks, pension funds, mutual funds, and hedge funds that may need to spread out the execution of a larger order or perform trades too fast for human traders to react to.
As Preteek Singh, Founder & CEO of LearnApp, explains algo trading:
“Algorithmic Trading as is evident from the name itself is using some algorithm to place trades for you. More than 80% of the trades in US markets are done through algos without any human intervention. This number in India is only growing after SEBI allowed algo trading in 2008.”
Why to use algorithmic trading?
Algo trading is used to make trading simpler and easier. Some of the main reasons why algo trading strategies are used are as below.
a. Remove human error: Algo trading keeps human emotions away in the way of realising profits and cutting losses.
b. Low and easy maintenance: Once the algorithm is set up, you can trade around your schedule any time of the day.
c. Capitalize on rare or special events: Creating algo to be used on infrequent events can be beneficial.
d. Supplement the existing strategy: Algo trading can be incorporated to your trading strategy to finely tune risk management.
e. Backtest: Backtest and refine your algorithms against the existing data to reach the best combinations of parameters to buy or sell.
f. Maximise opportunities: Pick your algo trading strategies to increase the exposure to opportunities in the underlying market.
Predefined strategies under algo trading:
1. Momentum and Trend Identification
These algo strategies are the simplest and most widely used that help you identify the market trend or early reversal of the trend. Algo strategies are based on price, volume, support, resistance or any other concept that the investor might feel right and confident on. Using data and technology, algo trading detects the correct trend using various strategies at once at a short period of time.
2. Delta Neutral Strategies
Delta neutral strategies include utilizing multiple positions to balance positive and negative deltas. A delta-neutral portfolio evens out the response to market movements for a certain range to bring the net change of the position to zero. Delta neutral strategies are manually not possible to manage as the continuous movement of an asset makes it tough. Algo trading makes it an easy approach to manage and update the delta of your position every second.
3. Position Management
Managing the position of trading is one of the major aspects that create the difference between an ordinary investor and a good one. Algo trading makes it easier as the position sizing will be based on commands predefined in the system.
4. Stop Loss Modification
One of the best methods to protect the profits and manage the portfolios is modifying stop losses. Algorithms provide you with easy solutions to manage risks in unpredictable markets. Systems can be fitted with strategies which change stop losses based on various technical techniques, price movements, etc on movement of the stocks in the portfolio. With algo, trading in larger quantities is possible as the risk is automatically managed by a predefined system.
Scalping is a strategy based on algo that lets the traders buy and sell a particular share or commodity at fixed internal. Forward scalping is when a trader buys at advanced market advances, while reverse scalping is when the buyer buys during a declined market.
These are the most basic concepts and strategies of algo trading, the most advanced form of trading in the modern world. Learning algo-trading strategies can lead to a much more result-oriented trading process.
If you wonder, why you must learn algo trading to be successful, this is what Prateek Singh has to say.
One common problem with many traders is that most of them trade based on their gut and do not follow a systematic approach to trading. Thus, when they face a string of losses, it becomes difficult for them to continue trading as emotions take over their trading decisions. Mixing emotions with trading is a sure shot recipe to blow up your trading capital.
The best part about machines/computers is that they can do the same boring work again and again without any emotions. If you have a systematic approach to trading i.e., having quantified rules for entry and exits, then it becomes easy to build an algorithm/code for your strategy.
Thus automated trading helps you to remain disciplined and continue to follow the trading system for a long period of time without letting your emotions affect your trades. Algo Trading also helps you to remove the manual trading errors that may occur while placing the trades manually. All-in-all, it helps you get the Algorithmic edge over manual traders and remain disciplined.
Learn more about Algo Trading from Prateek Singh at Bull Run Summit. Join us from 23rd to 25th July 2021 by registering at https://www.bullrunsummit.com/.