Algorithmic trading, also referred to as automated trading, is the type of trading that uses a computer program that follows a specific set of instructions to place a trade. Different programs vary in accuracy based on how they were programmed to make decisions. Most of the advanced automated trading tools also use Machine learning and artificial intelligence to improve their decision-making over time.
In theory, an automated trading tool can generate more profit for the trader than a human being because it can take decisions in real-time, which a human may not be able to do. Using a person to do full-time trading also requires them to be on their computer monitoring the market and charts to determine when to place a trade.
Sometimes humans make trading decisions under the influence of their emotions. However, using an automated trading tool also eliminates the influence created by human emotions.
How does algorithm trading work?
To explain this, consider the following scenario;
Suppose a trader wants to buy 100 shares of a stock when its 50-day moving average goes above the 200-day moving average. He may also want to sell the shares again when the 50-day moving average goes below the 200-day moving average. In this scenario, these conditions are input into the trading software to be executed automatically.
With such a program, the trader doesn’t have to stay awake 24/7, monitoring the graphs and charts and placing the orders manually. As long you have enough money on your account to execute the set instructions, the software will do this all for you without any extra input from your side. The role of the trade is to input the appropriate conditions. You may also adjust these conditions any time you wish.
Requirements for algorithmic trading
- Computer programming skills to code the program, hiring a developer to help you out or using an already made program. For most people, using an already built automated trading software is the best alternative.
- Full-time internet connectivity to have access to trading platforms to place orders whenever the set conditions are met
- Full access to market data feeds that the algorithm will base on to identify the market opportunities.
- You need to have historical data that you can be used to back-test the effectiveness of the program. You can use this historical data to test for various conditions to determine which ones work best.
Benefits of algorithmic trading
- It reduces the transaction costs incurred in trading
- Trades are made at a possible price since these automated tools react in real-time.
- It eliminates the risks due to human errors and taking decisions based on emotions.
- Trades are made in real-time to avoid significant price changes in price
- These tools can also be back tested to determine their effectiveness before deploying them
- Automated trading tools can be used 24/7 without worrying about errors resulting from fatigue.