Over the last few years, a revolution has taken place in the finance domain. Today, the way we analyze markets and the way we trade has undergone a radical transmogrification. What is the first image that comes to your mind when you think of traders?
Well, you might imagine a trading floor filled with men shouting at the top of their voices. But traders today are nothing like that you actually imagine. Traders today sit in front of the computer screens analyzing charts, data, and therefore make trades at the click of a button which is referred to as algorithmic trading.
Algorithmic trading makes use of algorithms to place a trade in order to make a profit at such a speed and frequency that will be impossible for the human traders. Algorithmic trading provides a more systematic approach to active trading than the methods based on a human trader’s instinct. It makes use of fast computer programs and complex algorithms to create, determine, and carry out the trading strategies for best returns. However, before implementing in the real market, the algorithms can be tested using the past or real time data, where the potential errors can be identified and hence, performance can be forecasted.
Why Use Algorithmic Trading?
If a trader wants to execute thousands of trades within a very short time frame, even where the market is witnessing the slightest of mistakes; algorithmic trading is must. With the help of algo trading, it makes easier to discover the prices, enhanced liquidity and makes the market more efficient. Moreover, if there are considerable differences between the bids and asks, algorithms can even suggest smaller spreads, and can make trades much more profitable.
Another hypothetical scenario where algorithmic trading can be efficiently used is a fund whose aim is to beat the returns of an underlying index. The fund managers need to constantly make buying and selling decisions in alignment with the price movements in the underlying index. An algorithm can help you automate a major part of tracking and transactions for the fund manager, thus, diminishing the administrative costs.
Benefits of Algorithmic Trading
- Trades can be executed at the best possible rates.
- Diminished costs of transactions
- Reduced risk of manual errors in making the trades.
- Trades can be done correctly and instantly, so as to avoid significant changes in the price
- Minimal chances of mistakes by the human traders based on emotional and psychological factors.
- Helps achieving consistency
- Enhances the speed of order entries
Algorithmic trading assists the institutional investors let up their efficiency of trade execution and spot the potential trading opportunities. Moreover, they also add liquidity to the market. You don’t have to spend a lot of time monitoring the markets as algorithmic trading can be done even without your continuous supervision. To trade accurately, algorithmic trading lets you back test. It becomes a huge task for traders to identify the pattern of the trading system that works efficiently and the techniques that does not go well for them. Algorithm trading would enable you to look back test the systems that actually failed and worked. Hence, this would help you make more income and minimize the risk of losing cash.
What exactly should be the way forward?
With technology playing a considerable role in the market operations, algorithmic trading is all set to grow. However, there is a need to analyze those high-frequency or high-volume trades that can result in sharp price movements. Talking about the average trader, it is best to lay stress on the fundamentals and invest in assets that can yield you significant returns over a long term.