The financial markets are sophisticated systems. Everyone willing to succeed in trading needs to devote enough time to educate himself the general concepts, prepare himself by choosing a broker, opening an account, etc., and study the market that he is about to enter.
It all pays in the end. An experienced trader is able to successfully navigate through the markets and enjoy the results of his hard work and devotion.
But the technological advance that led the markets into the digital era provides one more, different and new path to success.
It introduces the smart way of trading in the markets. It combines all the theories, analyses, experience and codes them into computer algorithms.
Algorithmic trading, as the name suggests, is computer-coded algorithms that automate the process of buying and selling FX and cryptocurrency pairs, stocks, options, futures.
It is becoming increasingly popular, along with electronic trading, and accounts for a good deal of all trading activities in developed markets.
The algorithm is a piece of computer code that follows a set of predefined rules and accordingly executes predefined steps. Every trading strategy could be turned into an algorithm, as long as there is sound mathematical logic behind it. It can be programmed to look for all kinds of variance in price, volume, indicator readings, time and uses technical analysis, indicators, charts, etc. Once the predefined criteria have been satisfied, a buy or sell order can be executed.
For an algorithmic system to be successful, the defined rules must be unambiguous and absolute.
An essential part of the algorithm making is testing it on historical data to determine its viability. This allows the fine-tuning of the system and the estimation of its success rate.
Algo trading can be used manually or in an automated fashion.
It can generate and send signals when certain conditions have been met, so that the trader can execute a deal. Or the process can be automated so that the generation, submission and execution of orders is done automatically (a.k.a. Automated trading).
According to the holding time of the trades, trading strategies can be categorized as low-frequency, medium-frequency and high-frequency strategies. HFT is the top achievement of Automated trading. These are algorithmic strategies that execute trades on a sub-minute time scale. The holding time of the trade is very short, the profit – very small, but the number of executed trades per day is in the millions.
Algorithmic trading holds many advantages over manual trading.
⇒ No emotions are involved in the decision-making process and emotions are something that quite often leads to poor results.
⇒ As the computer program cannot push the wrong button, there is zero probability for human error.
⇒ The algo trading systems monitor the markets non-stop, 24/7. They do not take naps, do not look away for a second, do not get bored.
⇒ Many markets can be scanned simultaneously for good trading opportunities.
⇒ There are strict risk management rules, coded into the algorithm itself and following them is not a matter of will, temperament or desire.
⇒ All rules are predefined and backtested.
⇒ Algo trading provides precise timing for placement of orders, as well as other parameters of the trade, like stop-loss and take-profit. The algorithm is able to place the order with a much better precision and in a matter of seconds.
⇒ There is no chance for an information overload, fatigue, distraction. The algorithm can easily take in as much information as needed and process it instantaneously.
⇒ Significantly reduces the level of experience and knowledge needed for a successful trading career.
Because computers respond so much faster and better than humans, it would be safe to say that algorithmic trading is the future. The automated systems react immediately to the changing market conditions. They are able to place the order, including the protective stop-loss and the profit-target, with precision and speed unattainable to a human trader.
In this fast-evolving world of technology, it takes an algorithm to have the edge.