What Is Algorithm Trading?

Every day and hour, our world keeps on changing. Technological advancements have changed how we go about our daily lives, including the way we trade. Algorithmic trading is one such result of technology that has changed lives and fortunes. It has become extremely popular over the last decade. 

What Is Algorithm Trading?

Algorithmic trading, or algo trading, is a type of financial market trading in which an algorithm is used to make buy and sell decisions automatically based on pre-programmed rules. Algorithms are sets of instructions that calculate the best execution price and quantity for trades in financial markets. Algorithmic algorithms are used for both equity and fixed income markets.

For example, an algorithm might determine that buying a security at this time would be profitable and then automatically place an order to do so.

Algorithms have been developed for different types of financial instruments, including equities, fixed income, futures, options and foreign exchange. They can be used to execute trades at any time during the day without human intervention or other manual processes such as posting orders to an exchange.

Algorithmic Trading uses software to create an algorithm, which is a specific set of instructions that a computer has to follow with trading instructions. After that, the computer system will produce the specific trade. Algo Trading also makes use of High-frequency trading (HFT) technology, which allows a system to generate tens of thousands of deals per second.

In other words, Trading algorithms are computer programs that execute orders on behalf of investors.

Is Algorithm Trading Useful?

Algorithmic trading offers investors several advantages over manual trading. It allows investors to take advantage of all the information available to liquidate positions quickly and effectively without having to spend hours poring over charts, looking for trends and other signs of market activity. It also means being able to follow stock movements in real-time via the system, which means no laborious phone calls or emails with brokers or other intermediaries are involved.

Another benefit of algorithmic trading is its ability to reduce risk. 

When investors trade manually, they're relying on gut instinct — if they have a feeling about something, it's easy to buy or sell based on that hunch alone. A lot of traders get lucky and catch the winning trades (or their riskiest bets), but many times they don't get lucky enough or make the right decisions at the right time. With automated trading systems, which are based on mathematical formulas that look for patterns in data points (such as price movement), they can be sure that no matter what happens during market hours, they will get the better end of the deal. 

Algorithmic Trading In India

Algo trading is perfectly legal in India. However, it has come to light that many investors are using illegitimate and unauthorized platforms for trading. SEBI, the Security Exchange Board of India, has issued a guideline concerning the matter to “provide a level playing field between Algo/Co-located trading and manual trading. Such platforms are being offered with "claims" of substantial returns on investment.” The guidelines can be read here.