In the world of financial markets, every millisecond and decision counts. This is why having a trading plan is essential. In addition, the use of technological advancements can significantly help in your trading success.
One of the ways technology can help you become a successful share trader is through algorithmic trading. It’s when you let the computer algorithms take charge of making decisions for your trades.
In this article, we’ll further discuss algorithmic trading that you can use when trading shares.
What is Algorithmic Trading?
Algorithmic trading, or algo trading, is a way of executing trades through the use of pre-determined instructions based on various factors. Some of these factors include market condition, quantity, and timing. The rule you set should match the current status of the factor before the algorithms can execute a trade.
So, as long as your rules don’t match the status of the factors, you can’t open or close a trade. At the same time, you should already know how to trade shares and have a trading plan to set up your criteria.
How Does It Work?
As the name suggests, algorithm trading uses a computer trading system. Although its concept has been introduced in the US since the 70s, the use of algorithmic trading has become better in recent decades.
Here are the main points of how modern algorithmic trading works:
1. Market Data Analysis
The first thing algorithms do is detect the trends, patterns, and other signals to identify trading opportunities. So, as an algo trader, you should understand how the stock market works, so that you can set your priorities straight.
2. Mathematical Models
Since the financial markets have large datasets, traders need to take time to analyse patterns and get to know the history. With the help of mathematical models, it’s easier to analyse the data and predict future value movements.
3. Execution Algorithms
As mentioned, traders should set their pre-determined instructions when using algo trading. Once the algorithms determine a trading opportunity, it automatically places orders and executes the trade. Additionally, it’s not a simple order placement, but it also figures out the way to minimise the losses. Of course, this still depends on the instructions you’ve entered.
4. Risk Management
When it comes to risk management, algorithms consider the market conditions and other factors. However, the basis of the position size and other risk management strategies depends on the trader. Whether you already know how to trade shares or not, you should also know how to implement risk management strategies.
Benefits of Algorithmic Trading
Since the financial markets are volatile, traders can benefit from algorithmic trading. As the market changes, the algorithms also apply the necessary changes needed for better trading results. Meanwhile, here are some of the main benefits of using algorithmic trading.
1. Speed and Efficiency
Processing a large amount of data, executing trades, and looking for trading opportunities are some of the things algorithms can do faster than humans. So, if you have enough knowledge about share trading, you can use algo trading for better trading results.
2. Accuracy and Precision
Another benefit of algo trading is to provide accuracy and precision in executing trades based on the criteria given. If your decision is clouded by the recent market changes and trading results, you can utilise algorithms for more accurate trades.
3. Cost Reduction
Algo trading can significantly help you save resources. Due to its automated process, manual processing and analysing of data can be done in a shorter time.
Challenges You May Encounter
Although algo trading provides various benefits, it also comes with challenges you should consider before using it as a smarter way to trade shares. Here are some of the challenges you may face when you opt for algo trading:
1. Regulatory Concerns
Since algo trading is becoming more popular, there are also many concerns about its impact on the financial markets. High-frequency trading affects the market stability which may result in an unfair advantage.
2. Market Impact
As mentioned, since algo trading can contribute to market volatility, many concerns have been raised about its impact on the trading community. For instance, if there’s a high frequency of trades under algo trading, those who aren’t using it might be at a disadvantage.
3. Technological Failure
Lastly, since algorithmic trading relies on technology, you may encounter glitches, errors, and other problems that may arise and lead to financial losses. So, instead of being too reliant on the power of algo trading, you should also manage your expectations and weigh your options.
Final Thoughts
Algorithmic trading is an innovative way to trade shares. However, you should also know how to trade shares and understand the dynamics of algo trading before you get started.
We hope this article helps you understand more about algo trading and why you should give it a try. Also, if you want to share your thoughts about this, don’t hesitate to comment below!
ABOUT THE AUTHOR
Aliana Baraquio has over 5 years of experience as a writer and market analyst. She specialises in developing beginner-friendly trading techniques and tutorials. Additionally, she suggests FP Markets as the top broker for trading CFDs and Forex.
