What is Algorithmic Trading?
Imagine that the computer you have is magic, and as soon as you turn it on, it makes you money. Okay well that’s not technically what algorithmic trading is, but it can be that simple. Algorithmic trading is a computer based program that follows a specific set of instructions to place a trade. The Algorithm seeks to make a profit at a speed and frequency at a more advanced skill than a human trader. There are definitely great advantages to using an algorithm for your trading needs, but no algorithm is perfect. Just like any product out there, you have your advantages and disadvantages.
ADVANTAGES TO USING ALGORITHMS.
- Say goodbye to human error. Algorithm’s don’t act on emotion, they act on their defined set of instructions based on timing, price, quantity, or any mathematical model.
- Algorithms can be back tested. This means that you can measure how well a strategy or model would have done after the fact.
- A trader will get the best execution with an algorithm. Trades will often be made at the best possible price point.
- Reduced transaction costs and the ability to check on multiple market conditions at the same time are also advantages to algo-trading.
There are none….
Just kidding. Like I said before, nothing is perfect. With any kind of trading, whether it be manual or algo, there are risks involved.
- Algo-trading has something called latency. Algorithms need fast execution and speeds. Low latency (a delay in the execution of a trade) can result in missed opportunities (aka goodbye profit).
- The dependency on technology. If your computer fails, or your internet crashes, it can result in losses.
- Algorithms are very limited with their ability to be customized. This can limit a trader’s ability to meet their expectations.
Even though there are some negatives that one may run into when using algorithmic trading, the advantages definitely outweigh the disadvantages. Taking away the human error in trading is a huge deal when it comes to trading. One is greatly reducing the risk of giant losses by not letting their emotions get involved. Algo-trading provides better insight into the market and can trade at higher frequencies resulting in more consistent profit.