To begin our understanding – First a couple of definitions:
According to quantinsti.com – “The automated trading system or Algorithmic Trading has been at the centre-stage of the trading world for more than a decade now. A “trading system”, more commonly referred to as a “trading strategy” is nothing but a set of rules, which is applied to the given input data to generate entry and exit signals (buy/sell).”
Wikipedia describes Automated Market Making or Algorithmic Trading as such: “Algorithmic trading is a method of executing orders using automated pre-programmed trading instructions accounting for variables such as time, price, and volume. This type of trading was developed to make use of the speed and data processing advantages that computers have over human traders.”
Simply put: Algorithmic Trading makes use of trading and rules-based Algorithms to carry out automated trading.
A Bit Further in-depth:
Often trading is done using a process of instructions (algorithms) that are automated and pre-programmed to account for such mutable variables as price, timing, and volume. This system is called Algorithmic Trading. Utilized, it will send small bits of a full order to create open-orders on the market.
These trades can be successfully carried out at a much faster pace and repetition than humanly possible. Opening up the possibility of generating quicker profits.
Profits are always welcome for traders; however, another plus in Algorithmic Trading results in more liquidity. Also, trades are more systematic because FOMO and other emotions are not a factor in trade activities.
Making use of complex formulas, mathematical configurations with some human oversight, Algorithmic Trading makes trading decisions to buy or sell assets on an exchange. This is often done using High-Frequency Trading, by which thousands of trades are made per second! Algorithmic Trading can be used in various scenarios, including arbitrage, order execution, and trend strategies.
Algorithmic Trading has grown in popularity and is widely used by rudimentary investors and corporate trading firms for various purposes.
Although it makes for faster trade execution and lowered costs, Algorithmic Trading can have a downside. It can provoke the market’s negative tendencies by causing flash crashes and loss of liquidity.
Suppose the algorithm is set with these two rules:
- BUY 5 BTC when the cost falls below XX,XXX
- SELL 5 BTC when the value goes above XX,XXX
The computer program will consider these two rules and monitor the asset values and place the buy and sell orders when the defined rules are met. The Algorithmic Trading system automatically sets the orders by correctly determining the opportunity to trade. This frees the trader from constantly observing charts and live prices or entering orders manually
Some of the Benefits of Algorithmic Trading:
- The BEST possible prices are accomplished in the trades.
- Order sequence is prompt and systematic (giving a high chance of completion)
- Reduced transaction costs.
- concurrent checks are made on market conditions
- The risk of errors when placing manual trades is significantly reduced
- The system can be checked to ensure a viable trading strategy is being used
- FOMO and human error based on emotion are also reduced considerably in the trades.
Algorithmic Trading could have useful applications for those who have little knowledge of or lack the desire to trade or, perhaps, time-restricted but still wish to benefit from asset trading.