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Automated trading has been a revolution for the traders. It has not only helped in reducing the risks associated with the trading process, has also been instrumental in catching the attention of a number of people who otherwise wouldn’t even have considered going into the trading market at all. Today, nearly 40% of all the trades that happen at the National Stock Exchange (NSE) happen via intraday trading strategies or automated trading. This new mode of trading has been able to garner so much success in so little time because of a plethora of advantages that it brings to the table.
Advantages of Automated Trading
There are a number of advantages of using computers to monitor the fluctuating markets. Let us take a look at some of the major ones:
Removing emotional bias
Two of the worst enemies of a trader that deals in algo trading strategies are fear and greed. Humans are often governed by emotions and against our emotional impulses, our logics often fail. This can cause us to suffer losses at the stock market. A computer, on the other hand, is incapable of feeling these emotions and works solely on logic. Therefore, automated trading helps us control our impulses and make sound decisions.
Backtesting
Backtesting applies trading rules to historical market data to determine the viability of the idea. An algorithm can’t just be good on paper. The stakes are so high in the stock markets that we have to be absolutely sure that our algorithmic trading strategies work. Backtesting is done by running the algorithm on previously obtained data to see if it would function properly in a live market. This makes sure that the algorithm would deliver profit.
Improving Order Entry Speed
Since computers can respond immediately to the fluctuating market conditions, automated trading enables you to generate orders as soon as trade criteria are met. When it comes to getting in or out of a trade, every second matters, and computers provide that. As soon as a position is entered, all other orders are automatically generated, including protective stop losses and profit targets. The stock market moves at a very fast pace, and it could be disheartening to see a trade reach the profit target or blow past a stop-loss level – before the orders can even be entered. This issue is not a concern when it comes to automated trading.
Diversifying Trading
While doing automated trading, a trader can operate multiple accounts and make the use of different trading strategies at the same time. By doing this, the trader can effectively spread risk over various over various instruments while creating a hedge against losing positions. Something that would be nigh impossible for a human to accomplish is done with the help of a computer within a fraction of a second.
With all these benefits, the automated trading has revolutionized the trading landscape by a great deal, and now, more and more traders are migrating towards this new and effective way of trading.
Technology has changed the way of our work. The financial markets are also not untouched by technology. At present, 30-50% of traders in India are using Algorithmic Trading, and 75% of traders globally. As we all know, Trading is the buying or selling of securities in financial markets. Algorithmic Trading has introduced mathematical algorithms into Trading and make Trading technological. Algo Trading involves building and implementing trading strategies.
What is Algorithmic Trading?
Algorithmic Trading is the most advanced form of Trading and highly technology-driven. It is the process of converting a trading strategy into an algorithm using computer codes. Computers execute the trade based on these algorithms. It has the advantage of speed and data processing over human traders. The other term used for algorithmic Trading is Algo Trading.
Algo Trading works on the pre-programmed automated instructions (an algorithm) for Trading. It is a computer program - step-by-step instructions to complete a trading task to achieve a particular outcome like increasing profitability, better execution, etc.
Who can take advantage of Algo trading? Experienced and professional traders, people who want to automate their trading strategies, Technical analysts who wish to automate their Trading, Jobbers who want auto-execution of trades, Wealth managers on behalf of their clients.
Automated Trading and algorithmic Trading are used interchangeably mostly. But these two are different terms. Algo Trading is the process of converting a trading strategy into a computer-based algorithm to execute the trade. The strategy can be implemented in an automated mode. While Automated Trading is the complete automation of the trading process.
The Automated Trading algorithms are based on the markets and the objectives of the trader. It facilitates quick profits in Trading in such a frequency that it is impossible for a human being. The price quote changes multiple times within a second. With the help of the algorithmic Trading, trades take place within the fractions of the seconds without human intervention.
How Does It Work?
It is a challenge to transform the trading strategy into an algorithm using a computer program to execute Trading. Highly skilled quantitative experts, researchers, and developers with a tech-focused approach are required to develop algorithmic trading software and make it more approachable. It must be easy to use. It is the final component of algorithmic Trading.
The primary technical necessities for algorithmic Trading are:
Computer-programming familiarity or Ready-To-Use trading software to do your Trading:
Setting up an algorithm requires some technical knowledge. You can buy algorithmic trading software or build it. You may have the technical ability to program the trading strategy, or you can hire programmers, or use Ready-to-use trading software. Take good care while choosing software for algo trading. You can suffer hefty losses in financial markets with faulty software.
Access to trading platforms and network connectivity with good strength:
You should have access to prominent trading platforms and reliable network connectivity to execute trades. Trading platforms should be famous, which provides live streaming quotes, research calls, integrated fund transfer systems, etc.
The algorithm monitors the market data feeds in search of opportunities to execute trades. Market data feeds allow traders to know the latest price for financial instruments.
You have built the algorithm as per your trading strategy. Now you need to backtest it before making it live on real markets. You should have the infrastructure and ability to check the efficiency of the system.
The availability of historical data depends on the intricacy of the algorithm, i.e. the rules and instructions implemented in the program.
Algo trading involves the formation of predefined algorithms (set of instruction) based on Algo Trading strategies so that the computers can execute the trade on its own, based on strategy. These smart algorithms are a bundle of backtested trading strategies. Backtested strategies are tested and evaluated on historical data. It helps to maximise profits.
The Core
The algorithms are designed that can be compatible with the strategy chosen by the trader. The traders can choose different strategy at a different point in time depending upon the market conditions and other factors.
Strategies are essential in determining the efficiency and profits that can be obtained from algo trading. Although the algorithm is placing the orders, it is the trader who develops the strategies to define how the Trading will occur. The traders decide what they want the computer to do, at what volume, at what price, at what time.
Let the machine evaluate the trading opportunities for you and suggest a trading decision with maximum profits.
In the world of intraday trading, Algo trading strategies are fast replacing the manual trading strategies amd are becoming popular day by because of a plethora of advantages that they bring to the table. Algo trading strategies have existed in the market for more than three years now, but there is still a large number of traders and investors who are unaware about its advantages over manual trading. Let’s take a look at some of those advantages that are revolutionizing the world of automated trading.
The tendency to get fatigued
Humans have a tendency to get fatigued, especially if they have to do a repetitive task. Because of this, no human, regardless of how great he is at his job, can ever deliver his 100% consistently. This is where computer programs emerge as a viable solution. Since programs aren’t capable of feeling fatigued and cannot get bored or disinterested, they can process more information in the same amount of time. This means more trading and more trading means more potential to reap benefits, which is the goal of every trader/ investor.
Humans can be emotionally biased
Humans are social animals and they have a tendency to be emotional as well – something absent in computers. While being emotional empathetic can serve you well in social scenarios, in analytical fields like broking, where you’re supposed to think rationally, it can be counterproductive. Computers are better in this regard because they can form algo trading strategies and stick to them in order to get the best results.
Computers are more accurate than humans
No sane person would ever compare the accuracy of a person and a computer when it comes to executing a given set of protocols. Since we’re rational beings, we have an inherent urge to rebel and challenge the rules – while it works well in social spaces; it is harmful in stock trading. Since computers are more accurate in terms of analysing data and drawing inferences from it, it defies all logic to still prefer manual trading – especially when a ton of money is at stake.
Computers programs don’t ask for salaries
The best thing about computer programs is that they never ask for salaries. A computer can work for longer durations than a human and still cost substantially less. This saves a lot of money that would otherwise have been spent on employing human resources. As they say, ‘a penny saved is a penny earned’, you can invest this money you have saved to further advance towards loftier business goals.
Computers can backtest
Unlike humans, computers can keep a precise record of every action they make and can analyse that data to test the effectiveness of previously employed algo trading strategies. If they worked, then those strategies can be used again; if not, then relevant changes can be made in the existing strategy.
While algo trading isn’t completely without risk, it still is a better option than manual trading and given the pace at which the advancements are happening in technology, it’ll only get better with time.
Trading is one of the most favoured methods to secure finances and to earn more money across the globe. Though the risk factor is high, with the little study of the market situation, it becomes easy to overcome the risk. Earlier, the process of trading was manual. Buying, selling, even the calculation of risk, was done manually. From the late 90s, to overcome human errors and to reduce costs digital trading came into play. Hence called Automated Trading. Although the use of computers was restricted only up to perform actions as per the commands, it was not suitable for risk management. To manage the risk, algorithms (set of rules for problem-solving operation) were introduced in computer programming. Also, algorithms were used to buy/sell assets at the right time, price and quantity. The process is called Algorithmic Trading. It is the upgraded and more accurate version of Automated Trading. Industry reports suggest algorithmic trading market size is expected to grow from $11.1 billion to $18.8 billion, globally by 2024.
Advantages of Algorithmic Trading:
Eliminates Human Error- Due to fatigue and stress, errors are commonplace leading to operational risk. Also, side-lining emotional aspects and focus on rational and unbiased trades is important for risk management. Introducing algorithms to automated systems eliminates the errors.
Accuracy- Shreds of evidence show algorithmic techniques are always more accurate than human decision making. Hence, more reliable.
Cuts Transaction costs- As systems don't require continuous monitoring, it needs fewer human resources. Eventually, results in decreased transaction cost and an increase in profit.
Back test- Back testing is the process of testing a developed strategy on previous stock market deals/situations. It gives validation to the strategy.
Applications of Algo Trading:
Many forms of trading and investment activities use algorithmic trading to get maximum benefits. Programmers have developed algorithm trading strategies. Following are the applications of Algo trading:
Long term trading- Investors who prefer large-volume investments or invest for a longer time, use algorithmic trading strategies to earn more yield. They use algorithm-based strategies to mark the arbitrary rise and low period in the market, to break the large volume of shares into smaller ones and release them into the market as per algorithm outputs. Also, they use algorithms to schedule their involvement in the market.
Short term trading- Intraday trading falls under the category of short-term investments. Investors buy and sell assets on the same day. The prime objective of Intraday trading is to earn profit by following and using market trends at the accurate time. Traders need to develop, use the appropriate strategies, Intraday trading strategies to earn benefits as the probability of risk is more. Bull flag trading strategy, Reversal trading strategy, Trend-based strategy, Pullback trading strategy are some effective Intraday trading strategies.
Systematic trading- Traders, who generally invest systematically, i.e. without taking a huge risk, follow the trends strictly, practices algorithmic trading. They find it much efficient than other techniques to calculate the risk.
Algorithmic trading serving all kind of traders by providing accuracy in outputs.
Requirements of Algo trading:
Trader, investor, programmer, anyone who fulfils above requirements can go for Algo Trading.
There are multiple Intraday trading strategies are available but algorithms trading gives the most suitable strategy to implement. These strategies are first backtested and then should be executed.
Considering the above-mentioned benefits of usage of automated systems enriched with algorithms, the future of trading will be much more exciting and secure.
No human intervention will be there, as the bots will be performing all the necessary operations. Chances of errors while predicting and or actual dealing will be very less.
Using algorithms combined with AI, will give more accurate results.
Algos can be programmed directly into the chips of bots for better communication.
Using backtested archived data, multiple trading accounts and strategies will be managed effortlessly.
The market crash will be the past as automated algorithm systems will be efficiently and more accurately predict future trends.
Many more exciting developments will be there in future as the bots will be taking charge.
References
1. https://finance.zacks.com/advantages-investing-stock-market-2054.html
2. https://www.investopedia.com/articles/active-trading/101014/basics-algorithmic-trading-concepts-and-examples.asp
3. https://cointelegraph.com/explained/algorithmic-trading-strategies-explained
4. https://blog.quantinsti.com/algorithmic-trading-strategies/
5. https://www.adigitalblogger.com/algo-trading/algo-trading-strategies/
https://kuants.in
6. https://www.algotrader.com
https://www.cryptohopper.com
7. https://economictimes.indiatimes.com/definition/algorithm-trading
8. https://www.5paisa.com/landing/algo-trading
9. https://towardsdatascience.com/algo-trading-101-for-dummies-like-me-b3938725d184
Algorithm trading requires various strategies to work successfully. In this article, we break out several common ones you can use as a trader for yourself or your clients. Just like Alphabot automatically places a trade-in your account and has in-built risk management capabilities, you can decide your strategies in conjunction with your relationship manager.
Different bots are offered on Alphabot to traders based on different risk-reward profiles.
Some of the strategies are as follows -
Mean reversion
The mean reversion strategy works on the proposition that the price of security tends to converge to an average or mean in due course of time. Hence, if the price of a security is appreciably high or low compared to its mean, it will tend to reverse course and head towards its mean value at some point. Apart from its primary name, this strategy is also known as a reversal or counter-trend strategy.
The way this strategy works is that the algo trading strategies use the historical price movement of a security to determine its mean value. It also assesses the upper and lower price level of the security and uses the combination of these data to determine when to execute a trade. When the prices of security are at the upper or lower bound, the algorithm intraday trading strategies trades with the idea that they will go back to their mean level.
This strategy can prove very beneficial when the price of a security is exceptionally high or low because in such a case, a reversion is nearly guaranteed. Thus, if the 30-day moving average of security is higher than its 120-day moving average, the algorithm will expect the price to decline towards the mean because it is too high.
One aspect of being careful of while using this strategy is when the prices are not too far away from the mean. In such cases, it may so happen that the moving average may catch up to the mean value of the security before the price can revert, thus negating any possible benefit from the trade.
Statistical Arbitrage
Similar to an arbitrage strategy, the statistical arbitrage strategy makes use of inefficiencies in prices of securities. It can be used when the price of securities is incorrectly quoted. Also similar to an arbitrage strategy, these inefficiencies in securities prices do not last long. Hence, it needs to be executed quickly, which is where automated algorithmic trading comes in handy.
But where this strategy is different from an arbitrage strategy is that while arbitrage refers to the price arbitrage available for security listed across different platforms, the statistical arbitrage strategy works when two securities are involved. These securities could be related to companies in the same industry or securities which behave similarly in a particular market. So while arbitrage strategy is adopted in the mispricing of one security listed across different platforms, statistical arbitrage makes use of price inefficiencies between two relatable securities.
Let's consider two companies from the information technology sector. Being of similar nature and from the same industry, their prices may behave similarly; in essence, they may be correlated in a precise manner. The algorithm studies the behaviour of these securities over some time. Once it finds inefficiencies between these prices, it can execute a trade before the price of one security has the chance to correct and maintain its movement with the other security's price. The level of inefficiency may be low, but a large enough trade can be quite profitable using this strategy.
*Sentiment-based trading
*
The sentiment-based Algo trading strategies make trading decisions based on news. There are several kinds of data being released daily. This data ranges from economical to corporate announcements. Market participants put forth their views on this data. Algorithmic trading systems based on sentiment assess whether the data point that has been released overwhelms or underwhelms the prevailing opinion.
These systems even use websites like Twitter to analyse the prevailing sentiment. Opinions expressed on that and similar platforms can help these systems arrive at a consensus. Using this information, these systems aim to predict the movements in prices of securities based on how the actual data turns out. Thus, the use of intraday trading strategies.
Across the two articles, we have provided you with details of different algorithmic trading strategies and how they work. There are other strategies too, but these are the ones which work as an excellent foundation for you as you explore the complex yet intriguing world of automated algorithmic trading.
Strategies are a natural way to get the maximum benefit out of algorithmic Trading. Based on the duration of holding the investment, Algo Trading Strategies are classified as Long term and short-term strategies. Automated TradingTrading has been enhanced with specific rule-based decision making.
Long Term Strategies
Pricing Strategies are more focused on the expected returns
Mathematical model-based Strategies are developed purely based on mathematical calculations, models.
Trend Based Strategies follow market trends. By using the statistics, patterns are studied, and further strategies are developed.
Arbitrage strategies use algorithms to figure out price differences and trade according to opportunities for profit.
VWAP (Volume Weighted Average Price) & strategies, break the large volume of stock into smaller and later issues them according to market conditions to earn more yield.
Implementation shortfall strategy uses algorithms to target involvement in dealing when stock prices are high and vice versa.
Short-Term Strategies
Short term strategies are generally executed in Intraday Trading strategies, where assets are bought and sold on the same day. Here stocks are not purchased for investment purpose but to earn the profit by connecting with the stock market trend. Algo trading strategies are incorporated in Intraday Trading to reap more benefits. Following are the Intraday trading strategies using algorithmic
TradingTrading:
Reversal trading strategies use algorithms to find out the highest and lowest points of the day. Based on these points as the secure time, price and quantity start reversing; it gives alerts to either buy or sell the assets.
Trend based strategies analyse the trends using Algorithms, and further strategy is developed.
Bull flag trading strategy based on the highest peak and steady decrease in trend during the day.
To get the target prices on the patterns of bull flag shape, algorithms are used. Based on these trends, ' strategies are developed.
Pullback Trading Strategy develops the low-risk buying opportunity.
Breakout trading strategy enables us to enter the market when prices change outside a specific range.
3 Efficient Intraday Trading Strategies Used in Algorithmic Trading
Algo trading is an automated practical approach to TradingTrading. Strategies make the trading process very fast and much more result-oriented. The trades can be executed to the point of specified price and volume in minimal time. It reduces the losses due to the time lag between the sale and purchase of securities.
When the algo trading is used with specific intraday trading strategies, it works amazingly well.
Here are a few back-tested strategies used by successful traders as a part of Algo trading. These strategies can undoubtedly lead to maximize profits with the correct execution.
It is the most commonly used and most straightforward strategy. There are no complex interpretations or predictions to be made. It is the momentum and trend-based strategy. You need to follow the trends, and the energy in the market and the trades will be executed accordingly. Trade will be based on technical indicators - the moving averages, the price level movements, channel breakouts, etc. If a set of conditions is fulfilled, then automated trading is generated.
When there is a difference in the cost of the securities on different stock exchanges, Arbitrage profits take place. The algorithm identifies the price difference immediately using the computers and executes a trade to enable buying on the low-priced exchange and sell on the high-priced exchange. Although the cost difference is not too much, here, we can compare the speed and accuracy of Algo trading and manual TradingTrading.
This strategy is mostly applicable to forex trading. Once the trade gets executed, arbitrage profits will be credited to the trader.
This is also one of the most popular and efficient strategies. The objective of this strategy is to quick-execute the order to the volume-weighted average price or the time-weighted average price. The orders are executed in small parts. The order is based at either volume-weighted average price or the time-weighted average price in specific opening price in defined time slots.
The algorithms are successful in releasing the orders in small parts with efficiency and accuracy in nanoseconds, which may not be possible by human traders.
To know more strategies, refer to our Algorithmic Trading Strategies - Part 1.
If you’re a stock market investor or are thinking about becoming one, this question must have crossed your mind: do algo trading strategies help generate profit? If yes, then to what extent? And most importantly, should you or should you not opt for automated trading? In the article below, we’ll try to answer these important questions.
What you do when you employ algo trading strategies is that you have software where you enter certain algorithms to make trades. Those algorithms basically enable the computers to make decisions on their own in the best interest of the investor as per the prevailing market conditions.
The most important benefits of automated training is that you get to do high-speed trading that is more accurate and less emotion-based – which could be a case if you’re doing manual trading. If humans are left in charge of trading, regardless of how good they are at understanding market behaviour – they are biased in certain biological ways that aren’t very useful. For example, a human may sometimes get overwhelmed with greed if things are going good, and panic if things are going bad, which may result in making of impulsive decisions.
But if you go for algo trading, since it is such a sophisticated, powerful and unbiased system of trading, you end up with best outcomes. The only problem with algo trading is that you need to spend a substantial sum of money to set up your infrastructure. You also need to have a certain level of technical knowledge in order to write the algorithms and execute them correctly. But once you set up the system, you can reap great profits and quickly overcome your initial expenditure.
Now, to answer the question as to what extent is algo trading possible, we need to divide the investors into two separate categories and analyze them properly. Those two categories are institutional investors and retail investors. Let us study them briefly.
Benefits for Institutional Investors
For institutional investors, algo trading is exceptionally beneficial. The reason for this is that they have a substantial capital at their disposal. This essentially means that they can do a very high volume of trade; so even if their profits per trade aren’t too huge, the overall profits are magnified because of the sheer volume of trades. Also we need to consider the fact that the institutions pretty much have all the necessary infrastructure and resources that are essential to automated trading.
They have the personnel who can write workable algorithms and they have the technical resources as well to set everything up nicely – therefore they are able to reap substantial benefits.
Benefits for Retail Investors
How beneficial algo trading is for the retail investors depends largely upon the competence of those investors. If a retail investor, for instance, has the technological acumen to be able write profitable algorithms and has a large reservoir of capital, then that investor can do well in algo trading. The problem however, is that without the large reservoir capital, which is the case with many investors, the trade volume is limited and the investor can generate only a certain amount of profit.
Moreover, the retail investors also have to pay the brokerage as well as transactional costs – which further lead to the reduction of profits. Yet, when you compare it to traditional manual trading, algo trading is still more beneficial as a higher volume of trades can be done in a much safer environment.
In the world of stock trading these days, algo trading is all the buzz. But before you decide whether or not you should dive headfirst into this novel concept and employ algo trading strategies to make the most of earning opportunities in the stock market, you should know how algo trading works. Algo trading is basically feeding algorithms to a computer as a finite set of instructions in order to obtain specific results.
In algo trading, the computer can be programmed to execute orders based on the market signals. Since the computers are more apt at handling large quantities of data, they are able to evaluate market conditions more efficiently to decide how the buying and selling decisions should be made. In fact, algo trading is so effective that it has taken over 40% of all stock trades on the National Stock Exchange (NSE) in India. Let us take at how exactly algo trading strategies work:
Formulating a strategy
Much like manual trading, automated trading also relies on creating a winning strategy. Trend following strategy, mean reversal strategy, arbitrage, statistical arbitrage, or market marking are some of the pre-defined fool proof strategies that one can program in the computers. You also need to make sure that you pre-program entry and exit positions; you can also minimize your risk by including contingencies like stop loss and profit limit.
Writing an algorithm
Once you have formulated a strategy, you need to write an algorithm to tell your computer how to execute that strategy. Once the algorithm is prepared, you need to get it approved by a chartered accountant. If it is passed by the CA, you need to take it to the exchange and demonstrate the strategy and how it has been converted into a workable algorithm. If it is passed there as well, it becomes ready to use in the world of automated trading.
Building or buying trading software
Software like Streak, MetaTrader, and AmiBroker are some of the most popular automated trading software that have produced results for a lot of people. Once you have the software, you’ll also need to buy data feeds from a vendor so that the algorithms that you have written can generate signals based on those live feeds.
Trading
Once you have completed all the above steps, the rest of the work is pretty easy. After you set up your system, all you need to do is look at the signals that are generated by the algorithm and then respond to them accordingly.
There can be a plethora of questions in a person’s mind when he/she is opting to optimize their investing game by employing algo trading strategies. One of the most common and sensible question that arises in a person’s mind is this: is algo trading legal? Would I be liable to legal ramifications if I indulge in algo trading? Would I end up losing my money?
To be honest, these fears are well founded, and any intelligent person who is entering a new domain should be worried about the safety of their assets. In this article below, we’ll try to settle these questions with appropriate answers and hopefully, make it easier for you to make a decision.
Algo trading refers to using computer-based algorithms to make much more informed and less risky buying and selling decisions. Of course, the algorithms have to be written by humans and they need to be approved by a CA before they can be implemented in the software. Now to answer the question about the legality of automated trading, we need to look at institutional investors and retail investors separately.
Legality for Institutional Investors
The answer to the question of whether or not algo trading is legal in India is ‘yes’. In fact, it has been legal in the country since the year 2008 when SEBI (Securities and Exchange Board of India) passed a regulation making automated trading legal in the country for institutional investors.
Ever since it was legalized, it has risen rapidly in the past decade – so much, in fact – that it contributes nearly 43% of all the trades that happen on the NSE (National Stock Exchange). SEBI has also passed a set of guidelines for employing algo trading strategies in the security market. SEBI has also allowed for collocation facilities among institutional investors, which means that upon payment of a rent, the traders are allowed to place their servers within the exchange premises. This prevents latency, which can lead to huge losses.
Legality for Retail Investors
Currently, there are no particular set of instructions or guidelines that have been passed by SEBI for retail investors so there is no answer to the above question: whether or not algo trading legal in India? According to SEBI, allowing the retail investors to get involved in algo trading would be like giving a nuclear weapon to someone who hasn’t even fired a gun in all his life. However, if there is some retail investor who aspires to be involved in algo trading, he needs to get himself certified as an Authorized Personnel; he also needs to acquire a dealer terminal from the broker that he’s in contact with. Also, the guy who is chosen to man the terminal also needs to have a NISM Series VIII certification.
Even now, SEBI is in the process of making the game fairer and give everyone a chance at making huge profits – whether it’s an institutional investor or a retail investor. The problem, however, is that the retail investors’ scene is so decentralized that things could go helter-skelter if everyone is allowed to enter the algo trading at once. The reason why SEBI is moving so cautiously is because big money is at stake, given the large volume of trades that happen through algo trading. But hopefully, in time, SEBI will be able to devise a policy that would give retail investors a fair chance at making the most of algo trading strategies.
Introduction
The stock market is always buzzing with activity. Trading is all about a keen eye for the ups and downs of the market. Investing in stocks requires knowledge, speed, and flexibility, among several different things.
There are new methods to achieve more profit from the stock market, such as Algo Trading. The basis of Algo trading is cashing on the hidden and quickly emerging patterns in trading which human being can miss. Machines can be programmed to read previous designs and read quickly emerging ones, thus bringing out the opportunities to trade profitably.
One of the reasons as well for its emerging popularity can be that earning is much more through algo trading than trading manually. Before jumping into the question of ‘Is Algo Trading right for you?’ it is necessary to understand the basics. We’ll cover a few terminologies here and then go further to answer the question.
Algorithm Trading:
Let’s start with understanding the term- Algo Trading.
Algo is short for the Algorithm. The steps you perform to achieve the desired result as an Algorithm. You set these instructions for the machine to process and execute. Trading is the transaction of stocks. To summarise, algo trading is when you define an algorithm to the machine for selling and buying shares. The Algorithm will be implemented when the conditions specified for the transaction are met.
How can Algo Trading be helpful?
Different aspects play an essential role in the buying and selling of stocks. Some of the causes of loss in the stock market can be:
• Inconsistency in decision making
• Inadequate analysis of the market
• Little to no knowledge about the current market scenario, etc.
This is where algo trading strategies can help.
The psychological aspects of stock trading can be controlled through the algo trading strategies. A machine doesn’t have any emotional inclination. Thus it can strictly follow the consistent trading system instructions. Also, there isn’t any comparison between the speed and frequency of a human and a machine.
Algorithm trading and Intraday Trading Strategies:
The algorithm trading works exceptionally well when used with intraday trading strategies. Intraday trading revolves around buying and selling stocks within the time limit of the market for the day. These are short-term trades and are for gaining considerable profits from the market at a given point of time in the day.
Intraday trading strategies differ depending on market conditions. Intraday traders need to be quick. Speed and knowledge about the market are crucial factors in intraday trading. This is where algo trading comes into play. The machine can process and execute the steps for the transaction at a much quicker pace than a human trader.
Are algo trading and automated trading the same?
Algo trading can either be semi-automated or completely automated, according to the choice of the human trader. Thus, people often use automated trading and algorithm trading interchangeably. However, both terms are not necessarily the same.
Algorithm trading is when the execution of the process is done based on the set of written instructions (or Algorithm). On the contrary, automated trading is the complete automation of the buying and selling process of stocks. Thus, the creation, submission, and execution of the order are entirely automated.
Advantages of Algo Trading:
Now, coming back to our initial question of ‘Is Algo Trading right for you?’ To know if something is beneficial or not, we must weigh its pros and cons.
There are many pros of Algorithm trading, which outweigh the cons by a significant margin. The advantages usually cover the aspects which are the contributing factors in the thriving trading process:
• Speed
When doing Algorithm trading, algorithms are pre-written, and the instructions can be executed automatically. The analysis can be done at a faster speed, thus providing better opportunities. The machine, with the help of the Algorithm, can scan and implement different factors at a crucially fast pace.
• Accuracy
In any business or trade, accuracy is the key to achieve successful results. Similarly, in algorithm trading, skill is essential. With the incorporation of machines in the trading process, common human errors are reduced.
When a person is trading manually, many of his judgments can be a result of greed or fear. But in the case of machines, there is no room for such an error. The device strictly follows the Algorithm to process the transaction.
To trade accurately, you can backtest the trading algorithm. Backtesting the trading algorithm is running the created Algorithm through the previously present data and studying its performance. In simple words, how viable the trading strategy is against historical data.
• Reduced Costs
You don’t need to supervise the market continuously. The trading process functions without it with the help of an algorithm. Also, there isn’t any risk of losing your revenue. You have a lot more time to do other things as the time spent on supervising the markets is less.
Intraday trading, as the name pretty much suggests, relates to the buying and selling of stocks on the same day, during obviously the predefined trading hours by relative authorities. The idea here is to buy and sell stocks within the duration of the same working day in order to generate profits – as much as possible.
Such is the nature of the stock market that the stock prices of different companies keep fluctuating every day. A person who employs intraday trading strategies seeks to benefit from this rise and fall of stock prices. Buy buying the stocks when they are cheap and selling them when they are costly, one can generate serious profits. Of course, there is a risk factor associated with the process and this is why one should be careful and probably seek help from a company that specialises in the broking field and have an automated trading system set up, that helps minimize the risk factor.
Automated trading systems allow the traders to set up specific rules for both the trade entries as well as the exits, and once these rules have been programmed, they can be executed automatically with the help of a computer. This system is so trustworthy, that nearly 75% of all the shares that are traded on the stock market, come from these kinds of systems.
There are certain things you should keep in mind before diving headfirst into uncharted waters. A rule of thumb that you should always remember is to sell first and buy later, in case the market is falling and vice-versa in the opposite case.
Another important thing to remember is to not get too greedy. You need to have contingencies stop loss and profit limits. Instead of breaking the bank on a single day, book your profits at regular intervals. This way, you’ll suffer lesser losses and will be able to stay in the race for a longer duration. Another healthy advice is to deal in highly liquid shares, and that too in small quantities – unless you’re a seasoned player.
Here’s another rule of thumb if you’re going into automated trading – make it a point to not trade in the first hour, as it is chaotic and unpredictable and it is the time when the opening range is established.
Sticking to your plan is also very important. Once your desired profit levels for the day are met, you need to pull out. If you don’t follow this discipline, you’ll end up incurring substantial losses.
Intraday trading, as the name suggests, refers to the process of buying and selling financial instruments on the same trading days – which, in effect, means that all the positions are closed before the market shuts down for the day. By making use of the intraday trading strategies, the investors or speculators, as they are called, are able to generate great profits. Algo trading strategies, on the other hand, make the process incredibly fast and much more result-oriented. Using algo trading strategies in tandem with intraday trading strategies, you can generate great profits with minimal risk.
Given below are some of the most popularly used, foolproof intraday trading strategies that are used to optimize the algo trading process.
Momentum and Trend Based Strategy:
This is, perhaps, one of the simplest and most straightforward ways of conducting trades in the market. You are not required to make any complex predictions. All you have to do is to follow the market trends and your algorithm will execute the trades accordingly. The decision to conduct trades will be made according to a number of technical indicators - the moving averages, the price level movements, channel breakouts, etc. Once a given set of conditions is satisfied automated trading happens.
Arbitrage Strategy:
Arbitrage strategy can come in handy if there is a difference in the costs of the securities between two different stock exchanges. The algorithm you are using will collect the information from different exchanges and quickly identify the two stock exchanges with the greatest difference between the prices of their securities. It’ll then buy the securities from the cheaper exchange and sell it to the costlier one to generate maximum profit. This is known as arbitrage profit. Although the profit gained per trade isn’t too high, but when you consider the speed at which automated trading works, you can make a substantial number of trades to generate quite a lot of profit.
Weighted Average Price Strategy:
This is one of the most popular as well as one of the most effective trading strategies. In this strategy, you are supposed to quick-execute the order to the volume-weighted average price or the time-weighted average price. It is to be noted that the orders are executed in small parts. The order is based at either volume-weighted average price or the time-weighted average price in specific opening price in defined time slots.
The benefit of using algorithms is that they are able to release the different orders in small portions, efficiently and accurately within a matter of nanoseconds. Needless to say, it is an impossible feat for human traders.
Automated trading, also referred to as algo trading, utilizes computer algorithms to make trades. Since the computers are much faster, precise and emotionally unbiased, they can really help increase the efficiency of trades. In fact, algo trading strategies have become so popular that almost 40% of all trades conducted on the National Stock Exchange (NSE) are done by using automated trading. Let us take a look at some of the advantages of algo trading that makes this method of conducting trades so popular.
Advantages of Algo Trading:
To answer the question of whether or not algo trading is right for you and whether or not you should conduct intraday trading with the help of computers, we need to assess the pros and cons of the method in question. There are undeniably some cons related to algo trading but they are massively over weighed by the pros, which include:
Speed
One of the best advantages of automated trading is that since the algorithms are already decided, the trades can conducted automatically and with great speed. Naturally, when the speed of trade execution is high, you’ll be exposed to more opportunities for generating profit. Since computers operate in a speed parameter known as MIPS (Million Instruction Per Second), the difference between the computational capacity of humans and computers is so significant, it would be ludicrous to even compare the two.
Accuracy
But we all know that speed means nothing unless accuracy is there. It is after all, the cornerstone of success in so many businesses. For computers, the question of accuracy is a moot one. If the algorithm written is good, then the accuracy of successful trades will also be good and vice versa. Humans, on the other hand are unpredictable; they make an incredibly intelligent trade decision in one moment and be swayed by emotions and external factors to make an absolutely asinine decision in the next moment. This is why algo trading is more predictable and hence, more accurate. In any business, you want to eliminate randomness as much as possible and algo trading strategies help achieve that target.
If you want to test the accuracy of your algorithm, you can backtest it. In backtesting, you subject your algorithm to previously available data to see how it’s functioning against it. By studying algorithm’s performance against old data, you can confirm the level of efficiency and accuracy of the algorithm.
Free time
By employing a trading algorithm, you can get rid of a lot of stress that comes from having to monitor the stock market day and night. The algorithm will take care of your sales, generate more revenue and reduce losses. As a result, you get time to enjoy your life.
Those who look at the past with a careful eye are the ones who are best prepared for the future, and this applies as much in automated trading as any other aspect of life. Are you wondering how? Let us explain.
Whenever an algorithm is written from intraday trading strategies, it cannot be simply implemented in a real life situation. The reason is that the stakes are so high in the trading business, mistakes cannot be afforded. Therefore, once the algorithm is passed and implemented in trading software, it is backtested. The process of backtesting involves using a new algorithm to make trade decisions on past data. Since the results are already known, it works as a litmus test for the efficiency of the algorithm. If the algorithm helps make the correct buying and selling decisions on the past data, it is likely that it would work on the future data as well.
Previously, backtesting was an ardous and lengthy process as it was done manually. But nowadays, three are many softwares that are ready made for testing algo trading strategies. Utilizing these software is a great way of saving time and resources. In case, you are planning about getting into automated trading, you need to keep a few things in mind.
Net Profit and loss
An experienced trader would know that there is only one goal in trading – to generate maximum profit with minimum risk. Therefore, it is always best to backtest your algo trading strategies on a broader time frame. For example, a trading strategy that gives the desired results in a time frame of 2000-2020 is much better than one that gives similar results for a time frame of 2000-2005.
Market Volatility
This term is used to refer to the inevitable fluctuations in the trade market. As a smart trader, your goal should always be to work with low volatility in order to reduce your risk while maximizing your profits.
Ratios
As is obvious from the name, some parameters are divided together to understand the nature of the stock and company. It comes in handy for managing money and in optimal position sizing. Two of the ratios that you should always be concerned with as a trader, are profit to loss ratio (P/L) and profit to equity ratio (P/E)
Average Return
The only scoreboard you’re going to have as a trader is the average return. Even though it cannot and should not be treated as a benchmark of success, it is an effective way of evaluating the success of a strategy. The more return you get from a strategy, the more successful you are as a trader.
Not long ago, most of the trading in India used to be done manually. But ever since automated trading entered the arena, more and more people have gravitated towards it and now, nearly 40% of all the trades that occur that the National Stock Exchange (NSE) are done via algo trading strategies. The reason why algo trading has become so popular in such a short span of time is that it provides unparalleled speed, accuracy and efficiency that just isn’t possible with manual trading.
Since automated trading is done with the help of complex algorithms, the speed and accuracy is maximized while the risk factor of human biasness is minimized at the same time. Not to mention that algo trading strategies help generate massive amounts of profits for the trader because the number of trades that can be executed within a given span of time are enormous.
Algo trading utilizes complex algorithms that have been backtested on previous data to generate great liquidity for the trader. The trading algorithm also has to undergo severe scrutiny before it can be used in the market – given the high stakes. The entire point of algo trading is to make the process of intraday trading strategies, faster and efficient while minimizing the level of risk associated with trading. The customers invest their hard earned money in the trades and they are taking a big leap of faith by trusting their future to a few lines of code that they themselves often do not understand. This is why it is absolutely necessary for algo trading platforms to perform seamlessly. The desired features of an algo trading platform are as follows:
• Quick trade execution.
• Having the option to connect with different exchanges.
• Both the market data and the company data should be available in real time.
• Both the latency as well as the time lag should be as low as possible.
• There should be an option for customization, as different traders have different needs.
• The platform must have the ability and the infrastructure for backtesting.
• There should be a provision to conduct trades directly with the broker’s network.
• The platform must have trained professionals who have expertise in writing trade algorithms that are according to the needs of the specific trader.
• A programming language that is independent of the platform is a must have to avoid confusion.
Investment and trading are not the same, even though a lot of people are under the impression that they are. To a layman, both these terms sound similar but to experienced traders, who have been into investment and automated trading as well as manual trading for years, they are completely different things.
A key difference between these two relatively similar words is the time horizon. Investment, usually, is for a longer period, whereas, trading can be done on a monthly, weekly or even daily basis (with the help of intraday trading strategies). If you happen to venture into a stock market, you wouldn’t hear too many people calling themselves an intraday investor or a long-term trader.
Intraday trading strategies are algorithms that are written in order to generate maximum profits on trades with minimum risk in a given stock market. Those algorithms, however, can’t be haphazardly written and implemented in the market as a lot is at stake. First, they have to be passed by a Chartered Accountant and only then they are implemented in trading software. After that, backtesting is done to ensure that the algorithms are working properly. All these steps, combined, make automated trading a safer, more efficient option.
It is only natural now that you should be wondering as to how a trading strategy is devised? Well, there are a number of ways in which you can develop a trading strategy. Different people have different ways of conducting an analysis but there are a lot of factors like market news, fundamental analysis, technical analysis etc. that have to be kept in mind before creating algo trading strategies.
How to write algo trading strategies!
• There are plenty of websites where you can go and select your trading strategies by using a simple form.
• Next thing you need to do is to test the strategies you’ve chosen in different market circumstances to check how they work in real life situations.
• If you get promising results, it would mean that the strategy that you’ve chosen is effective.
But before we conclude, we must emphasize that even though backtesting confirms the efficiency of your algorithms to a degree, it isn’t a hundred percent effective. Many a times in the past, it has happened that an algorithm that has done tremendously well in the backtesting phase hasn’t worked wonders in the real life situations. This is something that you need to get used to; as great as automated trading is, there’s a certain risk factor attached to it. But then again, risk is a part of the entire stock market. What matters is whether the reward is worth the risk or not.
Although it may seem pretty small in the world market as of now, but the Indian stock market is on am exponential growth curve. With the emergence of startups and other small and large businesses in the country, there has been a growth in the number of investors. In the present scenario, even the people belonging to the middle class are getting interested in the investment business, and this growth has been further augmented by the introduction of automated trading in the Indian stock markets. The growth has been so quick, in fact, that within a short span of time, 40% of all trades that happen on the National Stock Exchange (NSE) are being done with the help of automated trading by employing algo trading strategies. But before we delve deep into studying the Indian stock market, let us first understand what a stock is.
A stock is a kind of security that represents an ownership share in the company. When the companies are looking forward to accomplishing feats that require substantial capital, they go public and issue stock, and when they start making profits, the investors are rewarded with dividends. As an investor, however, your interest cannot be in just one company. Your sole purpose is to make money from money – this involves buying and selling stocks at the right time. While the experienced traders are pretty good at this, yet, as humans they’re prone to making mistakes – sometimes because of the greed of extra profit and sometimes because of the fear of incurring the loss. A computer program, however, doesn’t feel these emotions. It assesses the market conditions objectively and offers you the least risky path. This is why automated trading has become such a phenomenon in the Indian trade markets.
Talking about trading, if you want to start from scratch, you’d be required to open a trading-cum-demat account with a registered broker of BSE or NSE, and you’d also be required to link that account to your PAN CARD, Bank Account Number, a mobile number and email ID. Once you are done with these formalities, you’ll be eligible to trade on the stock market. This is when you should know about NSE and BSE.
NSE (National Stock Exchange) and BSE (Bombay Stock Exchange) are the two most important stock markets in the country. They facilitate a safe and controlled environment where you can conduct trades with minimal risks. They’re both regulated by SEBI (Securities and Exchange Board of India) which is an independent authority.
Roles and Responsibilities of NSE and BSE
1. To ensure that the exchanges have a level of transparency.
2. To increase the reach of the trading network.
3. To evaluate the stock prices.
4. To conduct transactions at high speeds.
5. To act as a barometer for the economy of the country.
6. To keep the investors safe and secure.
If you are new to the trading business, you shouldn’t plunge headfirst into uncharted waters, gives the stakes. Therefore, it is prudent to hire a broker, but when you do, you need to ensure that he isn’t charging you excess commission, he isn’t breaking the rules and most importantly, that he is a professional and not a self-proclaimed expert.
Signing up with a company that helps out investors with automated trading could also be a great idea. This way, you’ll get to learn about trading in a safe environment and since the intraday trading strategies are totally governed by computers, you wouldn’t have to worry excessively about your money.
