Algorithmic trading (also known as automated trading, black-box trading, or algo-trading) involves placing a deal using a computer programme that follows instructions (an algorithm). In theory, the deal can create profits at a pace and frequency that would be hard for a human trader to achieve.
Timing, price, quantity, or any mathematical model are used to define the sets of instructions. Apart from providing profit opportunities for traders, algo-trading makes markets more liquid and trading more systematic by removing the influence of human emotions on trading.
So, in today’s blog let us discuss How do Algorithms benefit the World of Stock Trading?
What is Algorithm Trading?
An algorithm is a series of clearly defined instructions to complete a task or process. There are also times when a human trader cannot handle large volumes of trading, necessitating an intelligent algorithm.
Computer-directed trading, also known as algorithmic trading, helps reduce transaction costs and allows traders to control their trading procedures. Thus, the big firms can absorb the expenses and enjoy the advantages that continue to gain from algorithm innovation.
How does Algorithm Trading work?
Let us take an example to understand how Algorithm works- Assume a trader follows the following simple trading criteria:
- A trader buys a stock when a stock’s 50-day moving average crosses above its 200-day moving average.
- A trader sells a stock when the stock’s 50-day moving average falls below the 200-day moving average.
Usually, traders had to manually enter the stock’s price at which they wanted to enter or exit from our trading platform.
But now, the computer programme will automatically watch the stock price and the moving average indicators and make buy and sell orders when the preset circumstances are met using these two simple commands.
The trader no longer needs to enter orders or check live prices and graphs manually. Instead, this is done automatically by the algorithmic trading system accurately detecting the trade opportunity.
Benefits of Algo-trading
Below are the benefits of Algorithm Trading.
- Increased Speed: The speed that algo trading provides is one of its most important benefits. The algorithms can instantly examine various parameters and technical indicators and execute the trade. The enhanced speed becomes critical since traders can capture price swings as soon as they occur.
- More Accuracy: There is less human interaction, which is a big advantage of algo trading. This implies a considerable reduction in the likelihood of errors. In addition, the algorithms are double-checked to ensure that human errors do not affect them. Although a trader can misjudge the technical indications and analyse them improperly, computer systems do not make such mistakes.
- The capacity to execute many trades quickly-An algorithmic transactions opens up a channel for traders to execute several trades while preserving accuracy and speed. The likelihood of making greater money by making more deals rises. The speed of transactions has quickly increased thanks to greater innovation and technological acceptance.
- Back Test Capability– To prevent excessive losses, traders must ascertain which components of their trading system are flawed and devise swift fixes. With algo trading, traders can back-test their trades using historical data and contrast them with recent data. This method is advised to determine whether transaction results would have remained the same.
- Transaction Costs Are Lower-Technology has been included in trading activities through algo trading, significantly lowering transaction costs. Traders don’t have to be hooked to their gadgets all the time to keep track of trades. Instead, a collection of instructions that track trade activity are used to programme the system. Without constant supervision, trades can be made, saving money and time that would have been spent continuously watching trading activity.
- Trading at a High Rate- High-Frequency Trading (HFT) is a distinct approach to algorithmic trading that uses highly effective and potent computers to carry out trades by predetermined rules. Due to the employment of sophisticated algorithms, these transactions happen at extremely fast speeds. Trading turnover is typically higher for high-frequency trading system users than for other systems. even with high
Is Algorithmic Trading Safe?
One of the safest methods of trading is algorithmic trading. Human trading is subjected to many variables and has a high risk of making mistakes that result in losses.
By entering data into a very powerful computer that utilises algorithms to perform and monitor trades, algorithmic trading provides security. However, various traders and investors in a market may have different opinions on the safety of algorithmic trading.
Before making an investment decision, it is frequently advised that traders should not anticipate winning the lottery because this style of trading takes time to master.
Building Algo-Trading System
Below are the steps of Building an Algo-Trading System
1. Key Difference between Equities and Futures
First of all, one should understand the difference between Equities and Futures. You are not investing in a corporate entity when you trade futures. Instead, you’re purchasing a contract to gain exposure to tangible assets like coffee, oil, or commodities like corn or soybeans.
Stocks, bonds, currencies, and even the weather are all covered by futures contracts that you can purchase. In the case of stocks, you might hold the share certificate in your hands or at the very least be able to see the security in your online account.
2. Working with a Trading System
Now that we have understood the main difference between equities and futures. Let us understand how to build a hypothesis-building system.
Let us know that you have a hypothesis or idea that whenever the Relative Strength Index of Nifty on the hourly chart goes after 70, and at the same time ADX is about 25, then it is a potentially bullish sign, and you want to buy.
And exit rule will be whenever the hourly RSI go below 55, and you will get out of the long trade.
Working with a Trading System
The steps to test a Hypothesis involve:
- Preparation And Building of Data
- Good Quality data, which involves the length and Corporate Action Adjusted Data
To understand how to build Algorithm Trading System in brief, you can join our course on Algo Trading For Everyone
Bottomline
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