If you are a trader, you must have gone through the pain of training on daily basis during market hours. Most of the time you will be getting exhausted due to continuously staring at the screen and watching price movements. But have you ever thought hoe big firms and institutional traders place and handle their trade, the answer is algorithmic trading. As they have to handle orders in millions within seconds so manual trading is out of scope for them.
Nowadays even retail traders with good coding skills are trying their hand in Algo trading. Even some broking firms like Zerodha offering these automatic trading features on their platform without coding requirements. Although these are not fully automatic trading but semiautomatic ones. For full automatic trading, you will require a certain amount of coding skills.
What is algorithmic trading?
In algorithmic trading, you feed certain instructions into a computer through coding/algorithms. Once you feed these algorithms, your work is done now all the trading work will be done by computers. Instructions fed in computers will be based on certain strategies like RSI, Moving average based. Such as If RSI moved above 80 then sell and if moved above 30 then buy. So if stock crossed RSI 80 level then the computer will automatically sell the shares. You don’t have to do anything just sit back and watch and if you feel then make some changes in strategies but in the trading part you don’t have to do anything.
Who uses algorithmic trading?
Big institutional firms such as mutual funds and pension funds buy/sell shares in bulk quantities. For them, it will not be possible to place orders manually because there could be a price difference due to a slight delay in order execution and it can result in big losses. So they take the help of algorithmic trading to buy and sell securities.
Nowadays retail traders have started using algorithmic trading. Most of them who don’t have coding background use the semiautomatic platform provided by many broking firms. Here the strategy is predetermined and you just have to choose them and fill in the details.
Another one is used by people with some coding skills, they make strategies according to their preference and fill them in computers. Some traders use this do call High-speed trading or scalping purpose. In this scalping method, the trading is very small ranges from 1-30 minutes.
Benefits of Algorithmic trading
- Trades are executed at the best possible prices.
- Trade order placement is instant and accurate (there is a high chance of execution at the desired levels).
- Trades are timed correctly and instantly to avoid significant price changes.
- Reduced transaction costs.
- Simultaneous automated checks on multiple market conditions.
- Reduced the risk of manual errors when placing trades.
- Algo trading can be backtested using available historical and real-time data to see if it is a viable trading strategy.
- Reduced the possibility of mistakes by human traders based on emotional and psychological factors.
Cons of algorithmic trading
- For most cases, knowledge of coding is a must
- Not all strategies can be coded due to complexity.
- It has the capability to give you both major profits and even big losses.
- It is not for everyone only for experienced individuals, because if you are new then there is the possibility of occurring loss.
Market Crash due to high-frequency trading.
On May 6, 2010, a disaster incident happened in the U.S stock market called Flash Crash. For this incident, the blame went to a type of algorithmic trading called high-frequency trading. Dow Jones plunged to its lowest intraday loss but recovered within minutes.
After investigation, it was found that this incident was happened because of one mutual fund named Waddell & Reed Financial. They sold future contracts of $4.1 billion dollars to hedge their positions. For this, they use the algorithmic trading method which caused the flash crash disaster.
After investigation, it was also found out that high-frequency trading was used for market price manipulation. Firms were using it to increase volume by generating high-volume orders using this method. But still, after this incident, there are not many regulations by the government to have some kind of regulations on high-frequency trading by these big institutional firms.
We at Tstock Mantra Investments by Amruta Tushar Ghone provide complete Financial Planning for an individual i.e., Mutual Funds, Insurance planning, Retirement planning, and so on.