There’s no question about the capacity of any human to become a successful trader, but there are limitations that could halt progress in the process. One of them is falling to emotional and psychological biases in making decisions. Sometimes traders are not aware of this, believing that all the conclusions drawn from indicators are objective and can be relied upon. But the truth is, there’s no such thing as absolutely unbiased analysis and decision. More often, there are human factors at play that may affect overall investment performance. It’s even safe to say that computers may at times produce better results.
Does that sound surprising? What you should know as a prospective trader is that there are options to go automated. The emergence of algorithmic trading in the financial market is proof that new technologies are geared to streamline businesses and banking systems. In fact, you might have been impacted by this silent revolution that’s been taking place for years already. Once you’re fully aware of the benefits that this option brings, you can make better decisions in relation to your financial goals. In case algorithmic trading is currently on your list, the following are some of the important points that you should know.
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What is Algorithmic Trading?
This kind of trading uses a computer program that follows a set of defined rules to place a trade. It’s also called automated trading, algo-trading, and black-box trading. Compared with manually-executed trading, algorithmic trading can generate profits at a speed and frequency that’s impossible for human traders. Usually, the set of instructions made by the trader is based on price, timing, quantity, or any mathematical model that matches financial goals. Aside from the profit opportunities, this trading makes the market more liquid and trading more systematic by eliminating the impact of human emotions on trading activities.
Benefits of Using Algorithmic Trading
Trading is a lucrative endeavor, but making profits is a hard challenge. That’s why many traders would build a sound investment portfolio at the beginning and follow through with appropriate strategies. Achieving financial goals is easy when the portfolio is aligned with the market fundamentals. When you use algorithmic trading for this purpose, some well-known benefits include the following:
- You can execute trades at the best possible prices
- You can minimize manual errors when placing trades
- You can avoid making mistakes from emotional and psychological factors
- You can reduce transaction costs
- Your trades can be timed correctly and instantly
- You can have simultaneous automated checks in various market conditions
- You can backtest the algorithmic trading using historical and real-time data
- You can make instant and accurate trade order placement
Popular Strategies for Algorithmic Trading
With the given benefits of algorithmic trading, you might be thinking of implementing it as soon as possible. But wait, you have to know first what strategies are best suited to your financial position. Yes, to employ algo-trading, you have to choose one or a combination of the following strategies:
- Trend-Following Strategy
Many traders who use algo-trading are following trends in price level movements, moving averages, channel breakouts, and other related technical indicators. These are the simplest ways to implement trading because they don’t involve any predictions or price forecasts. Instead, the trades are executed based on the occurrence of desirable trends, which are easy and straightforward to implement using algorithms.
- Mathematical Model-Based Strategy
There are mathematical models that allow trading on a combination of options and the underlying security. One example is the delta-neutral trading strategy that consists of multiple positions with offsetting positive and negative ratios. It compares the change in the asset price to the corresponding change in the price of any derivative.
- Trading Range Strategy
This is also called the mean reversion strategy that is based on the concept that the high and low asset prices are just temporary and would eventually revert to the average value. To use this strategy, you need to identify a price range and implement an algorithm based on that scale. This will allow trades to be placed automatically when the price of an asset breaks in and out of the defined range.
- Index Fund Rebalancing Strategy
Generally, index funds have definite rebalancing periods to match the holdings with the respective benchmarks. This strategy creates profitable opportunities for algo-traders who choose to capitalize on expected trades offering exact points of profits depending on the number of stocks or assets before index fund rebalancing. These trades are executed through algorithmic trading systems for timely execution and the best prices.
- Arbitrage Opportunities
When you buy a dual-listed asset at a lower price in one market and then eventually sell it at a higher price in another venue, you can earn a price differential as risk-free profit or arbitrage. You can use this strategy for stocks and futures instruments as the price differentials occur from time to time. As you identify price differentials and place the orders efficiently, you are opening doors for profitable opportunities.
- Percentage of Volume Strategy
Unless the trade order is fully occupied, this algorithm will continue to send initial orders based on the specific participation ratio and on the trade volume in the markets. There are also related strategies that send orders at a user-defined percentage of market volumes and adjust the participation rate when the asset price hits user-defined levels.
Algorithmic trading offers a great opportunity to grow your assets in the simplest and fastest ways. But still, success is not automatic when you use this strategy. You have to exhaust all possible methods of achieving your financial targets. Those options mentioned above are worth implementing in actual circumstances. It’s important that you monitor and evaluate how each one impacts your investment performance.
If you happen to be a crypto trader, there are now automated trading systems that can improve your existing strategies at hand. While it appears to replace the manual nature of trading, it can be used in combination with your own techniques. You are not restricted to implementing whatever approach that’s best suited to your personal goals and circumstances.