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Highlights
- Algo trading is currently being used in stock markets to leverage user data, past patterns, and a designated set of prespecified instructions to achieve fixed targets.
- Buy or sell orders are being executed utilising automated and pre-programmed trading instructions.
- Traders also use algo trading for arbitrage and trend trading.
An algorithm is defined as a set of instructions employed to solve a problem. Similar to every other sector, algorithmic or algo trading is currently being used in stock markets to leverage user data, past patterns, and a designated set of prespecified instructions to achieve fixed targets. Buy or sell orders are being executed utilising automated and pre-programmed trading instructions. Traders also use algo trading for arbitrage and trend trading.
In short, algo trades can deliver profits at a speed and frequency impossible for a human trader.
What is Algorithmic trading? What are its pros and cons?
In today’s world, large institutions, banks, and mutual funds employ algorithms to establish and liquidate positions at unimaginable speed. Logical coding has not only helped to improve trading performance and speed for market participants, but also reduced transaction costs.
How has algo trading evolved over the years?
It was in the 1970s when algo trading was first introduced in American financial markets. In 1976, the New York Stock Exchange (NYSE) introduced the Designated Order Turnaround (DOT) system for routing orders from traders to specialists on the exchange floor. Currently, over 60% of all trades in the US are executed by computers.
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Advantages of algorithmic trading
- Generally, large brokerages use algorithmic trading to reduce costs associated with trading.
- Market participants also employ algorithmic trades to create liquidity.
- Technology makes way for faster and easier execution of orders, making it attractive for exchanges.
- Algo trading is immensely useful in the rapid buying and selling of securities at small price increments. It helps investors and traders to book profit quickly.
Disadvantages of algorithmic trading
Even as the brisk speed of order execution acts as an advantage in ordinary scenarios, it becomes a challenge when several orders are executed at the same time without any human intervention. A flash crash becomes almost certain in such a case.
In addition, the liquidity created through rapid buy and sell orders can disappear fast, eliminating the chance for traders to profit off-price changes.
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