What is algorithmic trading?
Before the electronic trading took over, the stock trading was mainly a paper-based activity.
How does algorithmic trading work?
Algorithmic, or algo trading, is essentially a process of using an algorithm that perform buy and sell operations automatically based on certain predetermined parameters. Those may include timing, price, quantity, market volatility or any other factor the trader wants. It is also known as automated trading and black-box trading, this system can trade (and thus generate profit or loss) much faster than any human can.
For example, using a set of two simple instructions, a computer program can be written in such way, that it will automatically monitor the price of a stock or currency and place the buy and sell orders when the particular conditions are met. There is no manual intervention required and the trader no longer has to monitor the live prices and charts to place orders himself. The algorithm does his work for him very efficiently. Many algorithmic strategies fall into the category of high-frequency trading (HFT), which is characterized by high speed of trade execution and high turnover and high order-to-trade ratios.
What are the advantages of algo trading?
The ability to automate the trading process is a great asset. That means by using algorithmic trading strategies it is possible to ensure that orders are performed under what is perceived to be optimum buying or selling conditions. As orders are issued immediately, investors may be assured of not losing out on good opportunities. By comparison, manual orders don't come close to imitating the tempo of trading algorithms. In addition, as everything is performed automatically by the computer, human error is practically eliminated from the equation (assuming the algorithm is designed and programmed correctly). Furthermore, trading algorithms typically restrict or reduce transaction costs, allowing investors to maintain even greater profits. Ultimately, the trade in algorithms reduces the risks of acting on emotion rather than logic, one of the major problems for many human traders.
Is algorithmic trading risk-free?
We need to consider the risks and challenges we face as smart investors while using algorithmic strategies. For example, computer system failure, network connectivity errors, time-lags between trade order and execution, and, most important of all, imperfect algorithms. Remember, if you can place an algo-generated trade, so can the other market participants. Consequently, prices fluctuate in milli- and even microseconds. The more complex an algorithm, the more stringent back-testing is needed before it is put into action.
What is the difference between algo trading and copy trading?
Algo trading uses computer programs to trade at high speed and volume based on various predefined criteria such as stock prices and market-specific conditions, while trade copying is the use of software to replicate (or duplicate) trades to multiple trading accounts. As rule of thumb diversification is a vital thing in trading. You're encouraged to diversify your trading in order to be prepared for market challenges and drawbacks. For example, you can manually trade with a part of your capital based your trading strategies, you can use copy trading based on the signals from other traders and you can use a part of your capital for algorithmic trading (with expert advisors).
The use of different trading styles, markets, strategies in one portfolio will make your trading more stable and profitable.
Related article: What is trade copying?