What is Algo trading, and how to get started?

Authored by
Team Espresso
December 30 2022
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5 min read
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Algo trading is a computer programme that utilizes a predetermined set of instructions (an algorithm) to make a trade. Theoretically, such a trade can yield gains at a much faster pace and more frequently than by a human trader. 

Time, cost, and quantity models, among others, form the basis of the established instructions. Not only does algo-trading open up new opportunities for financial gain, but it also makes markets more liquid and more systematic by removing human emotion from the trading process. 

Fundamentals of Algo trading 

At its core, "Algo trading" means using software to automate your internet trading. Innovative technologies like Machine Learning (ML) and Artificial Intelligence (AI) form the backbone of most algo trading software. The technology is entrusted with scanning the financial markets on a 24x7 basis. 

Possible candidates for this category are various types of financial instruments or even certain types of assets. Some algo trading platforms, for instance, encompass forex, stocks, crypto, and commodities, while others like Bitcoin Code, are dedicated solely to bitcoin trading. The idea behind Algo trading is that it eliminates the need for human traders to undertake technical analysis. 

At this point, the algorithmic trading software can do one of two things. The first is to receive a real-time alert from the algo trading platform, which will provide specifics about the discoveries made by the programme. You'll be given the necessary entry and exit orders in the form of a trading signal. 

This semi-automated technique is perfect for those of you that want to reduce the tiresome process of spending hours analysing the market but still want an element of control over your transactions. 

The second is where the algo trading platform executes the buy and sell orders on your behalf, providing a fully automated end-to-end process. There is no assurance that the algorithm will be successful, but if it is, you may be able to earn money without doing anything. 

You can mimic the actions of successful traders by using the copy trading tools offered by some online brokers like eToro. Although not the same as traditional algo trading bots, this is still algo trading because it uses algorithm-based copy trading software. 

Strategies of Algo trading 

Now that you know what is algo trading in the stock market, let’s take a look at the top 3 Algo Trading Strategies that are widely employed by pros. These are: 

• Mean-Reversion Strategy  

• Trend-Following Strategy  

• Arbitrage Trading Strategy 

Mean Reversion Strategy 

If the stock price makes a sudden and unexpected move in one direction (either up or down), this technique predicts that it will eventually return to its longer-term average value. By placing purchase orders at deficient price levels and sell orders at extremely high price levels, the programme follows the heuristic belief that stock prices will eventually settle back at their long-term mean. 

Trend Following Strategy 

Using technical indicators like Moving Average, RSI, and MACD, among others, the algo in this technique attempts to identify a trend in the underlying stock market. When these indicators suggest an upward or downward trend, the algorithm immediately places orders to capitalize on it. This is the approach that most algorithmic traders follow. 

Arbitrage Trading Strategy 

Buying stocks on the National Stock Exchange and selling it on the Bombay Stock Exchange is a classic example of arbitrage. A stock that is listed on the NSE and the BSE have marginally different prices. If the share price of XYZ Company is Rs 50 on the NSE, it could be Rs 49.5 on the BSE. The price disparity may be more significant depending on its liquidity. 

Trading algorithms are developed to take advantage of price differences between different stock exchanges, either by purchasing shares at a lower price on one exchange and selling them at a higher price on another exchange, or vice versa. 

Now that you understand the basics of Algo Trading and its advantages, it's time to dive into developing your own Algo. 

Benefits of Algo Trading 

If executed properly, algo trading in the Indian stock market can yield positive results. Some advantages of algo trading include the following: 

Trade orders are filled instantly and accurately at competitive prices (there is a high chance of execution at the desired levels). 

Large swings in price are avoided because trades are executed promptly and optimally. 

Transaction costs are lower than for non-algo trades. 

Concurrent automated monitoring of several aspects of the market. 

There is no room for human error caused by their emotions and psychology. 

Real-time and historical data can be used for backtesting to determine if an algorithmic trading strategy is effective. 

Conclusion 

In conclusion, using an algo investment platform enables you to fully automate your investment and execution strategies. This is your best bet if you want to acquire a piece of the action in the financial markets. However, you need to learn to put it in action. For the same reason, algo trading platforms are ideal for investors who don't have the luxury of devoting countless hours to learning about various financial instruments. To use Algo trading software, all you need to do is open an account with the service of your choice, deposit funds into it, and sit back and relax while the programme handles everything else. That's why it's essential to find an Algo trading broker that's also regulated. 

FAQs 

Q. Is it acceptable to use Algorithmic Trading? 

The use of trading algorithms is not illegal. There are no regulations or legislation that restrict the use of trading algorithms. Some traders may argue that this practice leads to a less-than-fair market environment. Nonetheless, it is not against the law in any way. 

Q. In what ways may I study algorithmic trading? 

Quantitative methods, like analysis and modelling, are crucial to the success of algorithmic trading. If you intend to invest in the stock market, you should be familiar with the fundamentals of financial markets and trading. Lastly, a background in coding or programming would be helpful, as algorithmic trading frequently uses technology and computers. 

Q. What would they say if you were to ask an algorithmic trader what programming language they use? 

Algorithmic traders frequently use C++ as their programming language of choice due to its efficiency in handling large datasets. However, C and C++ are more complex and demanding languages. Therefore, finance professionals hoping to enter programming may be better off switching to a more manageable language such as Python.




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