Blog Details

26 Jun

The stock market is rapidly changing with technology. Technology has created several opportunities, including the possibility for a new generation of traders to pursue trading as a full-time career, particularly in the challenging days following the Covid-19 outbreak. One such technology that has completely changed the way people trade stocks is algorithmic trading. Trading professionals now have a competitive advantage that allows them to advance their knowledge and surpass traditional trading.

The Securities and Exchange Board of India (SEBI) legalized algorithmic trading in India in the year 2008. Direct Market Access (DMA) was initially only available to institutional investors, but the trading community quickly adopted it due to cost reductions and better execution. To increase trading speed, The National Stock Exchange (NSE) began leasing additional 54 colocation server "racks" to broking firms in June 2010 and conform to international markets.

Algorithmic Trading

Algorithms (Algos) are a set of rules that are used to complete a certain task. To earn profits at a rate that is impractical for a human trader, algorithms are used to automate trading. In algorithmic trading, it creates rules based on models of time, pricing, quantity, and mathematical models. Automated trading and black-box trading are other variants of algorithmic trading.

A trade is made in algorithmic trading by a computer program that follows a defined set of instructions. The illustrated instructions are based on any mathematical model or the timing, cost, or quantity consideration. Algorithmic trading promotes market liquidity and standardizes trading by reducing the impact of human emotions and errors.

Algo trading has the advantage of having back-testing capabilities, enabling users to test their strategy and see how it does. Algorithmic Trading simulation can be used to evaluate your approach in real time and avoiding to execute any actual trades.

Benefits of Algorithmic Trading

The benefits algorithmic trading offers over manual trading are a major factor in its rising popularity. Algo trading has advantages such as speed, precision, and financial savings.

  • Speed: Because algorithms are pre-written and run automatically, speed is the main advantage. These transactions take place quicker than humans can perceive, in fractions of a second. The benefit of algorithmic trading is that it can scan and execute a number of indications at a rate that no human could equal. Since trades can be evaluated and completed more quickly, more opportunities are available at better prices.
  • Precision: Precision is another advantage of algorithmic trading. When a machine completes a transaction on your behalf, you are protected from the risks associated with human transactions, such as accidentally entering an incorrect agreement. Manual submissions are much more likely to purchase the incorrect currency pair or for the incorrect amount than a computer program that has been properly verified to ensure the correct order is entered.
  • Financial Savings: Automated trading also has the benefit of lower transaction costs. Algo trading allows trades to be conducted without constant supervision, so traders don't have to keep an eye on the markets. The significant time reduction for trading lowers transaction costs since there is a lower opportunity cost of continuously monitoring the markets.

Different forms of Algo Trading

  • Execution: Execution refers to the process of carrying out a trade or investment order, which involves transmitting the order to the market, matching it with a counterparty, and completing the transaction. It includes the steps of order routing, trade confirmation, and settlement, ensuring the timely and accurate execution of the transaction. Pension funds, mutual funds, and insurance companies use algo trading to acquire stocks in huge quantities when they don't want to affect stock prices through discrete, high-volume transactions.
  • Arbitrage: Arbitrage is a trading strategy that takes advantage of price discrepancies between two or more markets, aiming to profit from the price differences by simultaneously buying and selling assets or securities. The goal is to generate risk-free profits by exploiting temporary market inefficiencies. Automated trade execution benefits market makers, such as brokerage firms, speculators, and arbitrageurs. Algo trading also helps to create enough liquidity for market sellers.
  • Systematic Trading: Systematic trading offers potential benefits such as increased speed, efficiency, and consistency in trade execution, as well as the ability to analyze large amounts of data and identify patterns that may not be easily recognizable by humans. It can also help remove emotional biases and improve risk management.

Different Algo Strategies

  • Trend Following: The most widely used method in the world is Trend Following. This time-tested tactic accounts for close to half of the assets of hedge funds. It's a straightforward idea in theory, but putting it into practice can be difficult. Nevertheless, there is a lot of potential for alpha creation if done methodically and with discipline.
  • Smart Beta: The goal of smart beta is to combine the advantages of passive and active investing. Because they employ different index construction rules, smart beta indices are distinct from conventional market capitalization-based indices. Its main objective is to transparently collect investing characteristics of market inefficiencies. Multiple weighing techniques, such as volatility, liquidity, value, size, quality, and momentum, may be used by innovative beta strategies.
  • Means Reversion: The next most popular approach is Means Reversion. This tactic is successful in range-bound markets. Most of the time needs fall within a 60%–70% range. Because it can be disastrous, the risk is greater (i.e., when the trend is strong). It can be used in conjunction with a trend strategy to get the best of both worlds.
  • Arbitrage: A trade known as arbitrage occurs when a commodity, security, or sum of money is bought and sold on two different markets practically simultaneously. Utilizing price differences between different exchanges for the same financial product is the aim of arbitrage. Arbitrage is legal but also helps markets by enhancing market effectiveness and supplying trade liquidity.
  • Market Making: A market maker merely intends to make a tiny profit (spread) between the prices at which they buy and sell shares, and they want to do it as frequently as they can. Market makers put orders on both the buy and sell sides. Market makers utilize a number of methods that depend on price distribution to make money.

In conclusion, algorithmic trading has revolutionized the financial markets by introducing speed, efficiency, and automation to trading strategies. By leveraging advanced mathematical models and historical data analysis, algo trading can execute trades with precision and consistency, removing human emotions and biases from the equation. It offers numerous benefits such as improved liquidity, reduced transaction costs, and enhanced risk management.

However, it is essential to continuously monitor and adapt algorithms to changing market conditions and ensure compliance with regulatory frameworks. As technology continues to evolve, algo trading is expected to play an increasingly significant role in shaping the future of finance, empowering traders with powerful tools to navigate complex markets and maximize returns.

Get excellent returns on your stock market investment with Algo Trading.

Archers Wealth has established itself as a forerunner in investment research and development by having timely, in-depth analyses of businesses, markets, industries, and global economies.

Archers Wealth offers leading-edge algorithmic trading to maximize your investments in the capital market with highly professional and transparent practices, and calculated risk methods.