Stock market trading has been the backbone of the financial industry. Even the conventional methods of buying and selling shares in the stock market have actually witnessed a huge transformation over the past few years.
The sudden shift is because of the technological developments in the trading world, one of them is Algo Trading or Algorithmic Trading.
Such type of trading platform started to resonate profoundly within the stock market and has reshaped various trading methodologies opening new avenues of income for the traders.
What is Algo Trading?
Algo Trading or Automated trading, mainly involves the use of various computer software and programs to buy and sell securities at a speed that will be just impossible for a human trader.
Traders make use of a predefined set of rules stating the execution of trades, based on variables such as price, timing, quantity, or mathematical model.
These predefined rules make this decision-making procedure more systematic and less influenced by human emotions.
Also Read: 8 Best Algo Trading Softwares in India
How Does Algo Trading Work in the Stock Market?
Algo trading uses certain complex formulas, along with mathematical models and human oversight, to make the right decisions. Investment firms, traders, and hedge funds make use of algo trading to reduce costs and speed up the trading process.
Algos will follow trends, determine when to trade and can also execute trades on own. It happens within fractions of a few seconds and without any need for human intervention.
The primary steps involved are:
- The trader dictates the set of rules for the trade.
- These rule will be converted into a computer program.
- The program continuously monitors the market and automatically executes trades when the specified conditions are properly met.
Why Is Algo Trading Mainly Preferred By The Traders?
The primary reasons why Algo trading is become quite popular is because it is very time-efficient. Algorithms execute proper trades within milliseconds, which is much faster than it can be done manually.
Additionally, such a style of trading reduces the risk of human mistakes and guarantees that trades are executed at a best possible rates. Algo trading even reduces transaction costs and allows real-time automated checks on the multiple market conditions.
Benefits and Drawbacks of Algorithmic Trading
Like all trading systems, Algo trading also comes with its own set of benefits and drawbacks, let’s check them out:
Benefits:
- Speed: Algorithms can react to the market conditions and execute trades within milliseconds.
- Precision: Algorithmic trading reduces risk of the manual errors when placing the trades.
- Backtesting: Algo trading allows traders to backtest making use of the real-time and historical data to evaluate if the trading strategy works before they plan to execute it.
- Cost-efficient: Trades will be placed automatically once right criteria are met, hence resulting in lower transaction costs.
Drawbacks:
- System Failure: Algo trading is subjected to technological issues such as network or power failures, hardware breakdowns and software bugs.
- Over-optimization: A risk that algo trading will become very complex and overfit that will lead to inaccurate predictions.
- High investment: Algo trading demands mainly on substantial resource investment for the backtesting, development, and maintenance algorithms.
Future of Algorithmic Trading
The finance world is moving fast towards the digital platforms, and the rise of Algo trading is one of the best example of this transformation. Most of the investors across the world are moving towards algo trading for substantial benefits.
With the constant advances in the current technology and algorithms, this mode of trading has a very bright future. Nonetheless, as this area still continues to evolve, it is very important for the traders and investors to stay vigilant of various challenges that it can pose.