Humans are becoming more dependent on artificial intelligence more than ever. The University of Georgia research report claims that mankind finds computers more reliable than humans. It is proof enough that modern mankind is fully surrounded by technology. The investors, traders, and trading market have not been left from this list.
What is Algorithmic Trading?
Trading algorithms are used to place large orders. The speed of algorithm trading is extremely high, which is why it helps achieve competitive pricing and immediate delivery of trades. Algorithms always save time and vital resources so that traders can do their other jobs, such as analyzing the trading data, instead of manual order placement.
How Does Algorithmic Trading Work?
What Are The Types of Algorithmic Trading Strategies?
Advantages of Algo Trading
- Traders' emotions work in trading. But in the case of Algo trading, removing emotions from trading allows traders to make better decisions. Traders don't even wait for a second guess for buying or selling orders because the algorithm automatically does it. It enforces a system and discipline, which are the keys to success in a volatile market.
- Automated trading systems work to improve the overall speed of the process. Computers also respond instantly according to the algorithm and help in faster transactions. Hence, more orders are made in a shorter time, bringing more precise results.
- Algorithmic trading uses automatic algorithms to assess market data before making orders. A human trader might take a few minutes or seconds to make a decision, whereas an algorithm has the potential to make an instant decision. This is especially helpful in turbulent markets where a quick reaction is necessary.
- Automatic Algo trading reduces the time between submitting an order and closing it. This means it impacts the open and close ratio. Automated trading isn't paid unless the whole process is successful; Thus, there is no need to pay any additional cost.
Risk & Challenges of Algo Trading
Technical risks include system failures, data inaccuracies, and even programming errors. This is the reason why traders face incorrect signals in trading algorithms. Sometimes it leads to poor trading decisions and significant losses. To mitigate the technical risks, regular maintenance and proper back-testing are necessary. It ensures that the algorithms are functioning properly.
Unexpected events, price fluctuations, and market volatility are ideal examples of market risks. For unprepared traders, it might bring losses. Managing market risks is easy when traders use risk management tools and diversify their portfolios towards better market exposure in different markets.
Operational risks include regulatory compliance, liquidity, and even cybersecurity. There are high possibilities of a data breach or ransomware attack, which may result in the loss of sensitive information. Traders can handle these operational risks effectively by staying up-to-date with regulations, implementing advanced cybersecurity measures, and maintaining adequate liquidity.
Behavioral risks are created by emotional biases, overconfidence, or even wrong practices. Sometimes these risks lead traders to apply the wrong backtest trading strategies and incur losses. To manage these behavioral risks, traders should know how to implement proper discipline in their trading strategies. They should use risk management tactics to control market exposure.
Difference Between Algo Trading & Manual Trading
|Emotions can influence many decisions.||No fear or emotions can impact the trading decision.|
|Buying or selling can be done without predefined rules.||Algo trading can be done with the right algorithms that are tested and predefined.|
|The trader has to monitor 24/7.||The Algo bot tracks the signals and also monitors the market constantly.|
|Risk management is necessary to avoid losses.||The Algo bot tracks the signals and also monitors the market constantly.|
|No success is guaranteed because human emotions impact the strategy's efficacy.||The chances of success are higher because each algorithmic strategy here is tested.|
|Price slippage can happen significantly.||Here the positions are opened and closed based on predefined levels, reducing the chances of slippage.|
Role of Technology in Algo Trading
- The latest advancements in AI and ML algorithms are one of the biggest improvements in Algo trading. Due to these technologies, a large amount of data can be found that human traders might not notice manually. These technologies assure better returns, offer more precise results, and help make effective trading decisions. The timing required in trading to execute the right strategies is also reduced because of the use of AI and ML.
- Cloud computing is another technological advancement in Algo trading. With this, traders can get instant access and process a massive amount of data anytime and from anywhere. Whether beginners or professionals, they can participate in Algo trading without using expensive hardware and infrastructure. It is especially helpful for traders managing high-volume trades.