What Do We Mean By ‘Algorithmic Trading’?

  • Dec 01, 2018 AEDT
  • Team Kalkine
What Do We Mean By ‘Algorithmic Trading’?

Understanding Algorithmic Trading: From many years, trading of securities like stocks occurs electronically; and the orders are entered into the market by broker operators, however, due to technology advancement there has been an increasing trend towards orders being generated by computer algorithms. This type of trading, ‘Algorithmic trading’ or ‘Algo-trading’ helps in reducing impact of costs from the market on clients while they can vouch for some specific trading opportunities. The term ‘Algorithmic,’ when linked to trading, can be comprehended as computer-generated trading activity. Thus, this works on strict predetermined rules and requirements that need to be adhered to have successful transactions. The benefits of Algorithmic Trading include enhanced trade execution, improved efficiency regarding a number of transactions executed on a daily basis, lowering of average value associated with each transaction, and so forth. In terms of costs, this type of trading supports in minimizing market impact of big orders; and this, in turn, reduces costs related to trading. The most common of these is VWAP (volume weighted average price), which is an algorithm designed to achieve, or increase, the volume weighted average price of a security over a day. Then you have situational algorithms that are customized ones and are based on changes in data, information or any event. Then there exist trend driven algorithms wherein trading decisions are based on the trend of benchmark technical indicators like 50-day and 200-day moving averages.

Growth in the future: The algorithmic trading seems to be supported by ASX as the exchange is involved in facilitating the increase in algorithmic trading based on continuous investment in technology. Further, structuring of fees for related transactions and setting up a platform with multiple services under a single location are few strategic moves made by ASX to cater to this side of trading. ASX projects that algorithmic trading in Australia will increase sharply in the coming years, driven by further technological advances and the increase in a diverse range of investors. In particular, there is a possibility that algorithmic trading might witness an uptrend in case licenses are granted to alternative market operators who can then trade securities listed on ASX while sophisticated algorithmic traders are yet to become more active in the market to benefit from new arbitrage opportunities. This is based on developments at the back of liquidity fragmentation across various trading platforms. Even for licenses to be sought and granted, appropriate legislation or regulation needs to be established and enforced by the government in order to maintain harmony with regards to conducting transactions and maintaining integrity across the market. Further, these aspects should be looked from public interest perspective while keeping a check on competition among market operators. The future of algorithmic trading thus resides on the regulatory framework.

Usage of Algorithmic Trading: Trading algorithmically has emerged as one of the best ways to remove emotion from the investors’ trading decisions and this trend has been noticed across the globe. At times the investors hold on to falling stocks, thinking that when the price will move up, they will book profit. Sometimes the investors prematurely sell out the stocks of profitable positions only to see them getting double, then triple, then quadruple in near to medium term. Moreover, the significant part of algorithmic trading can manage market impacts, apportionment of assets, and other trading plans. While many trading algorithms are being implemented at the global front, these may not be a good fit for Australia in terms of impact on domestic equity market and market users that majorly rely on non-algorithmic trading. On the other hand, Algorithmic trading has been said to increase the liquidity, and this needs further understanding from practical experiences. The growth in algorithmic activity is thus subject to many needs under which Australian regulatory framework and supervisory infrastructure need to be well-established.


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