Algo trading: how algorithms will change the way you buy and sell stocks
Algorithmic trading was introduced and licensed in India in 2008 by the Securities and Exchange Board of India (Sebi). Initially, it started with Direct Market Access (DMA) and was restricted to institutional investors, but due to the cost advantage and better execution, the trading community welcomed it with open arms. Exchanges also played an important role in its adoption by offering colocation server “racks” for rental to brokerage firms in June 2010, in order to improve the speed of trade and align with international markets.
Understanding algorithmic trading
Algorithmic trading refers to the use of programs and computers to generate and execute (large) orders in markets with electronic access. It generates a speed and frequency that is impossible for a manual trader to achieve. Algorithmic trading strategies involve making trading decisions based on predefined rules that are programmed into a computer. A trader or investor writes code that executes transactions on behalf of the trader or investor when specified conditions are met.
The predefined rules are usually based on schedule, price, quantity, or some other mathematical pattern. Besides the profit opportunities for the trader, algo-trading makes markets more liquid and trading more systematic by eliminating the impact of emotions and human errors on trading activities.
Since the algorithms are written in advance and executed automatically, the main advantage is speed. In addition, it promotes features such as automation, eliminates human intervention and emotions, minimizes slippage, allows flexibility and promotes ease of use, provides deep data mining and exploration, and systems protection and warning against the most common human errors.
The beauty of Algo trading is that it has aspects like back-testing, where individuals can execute their strategy and see the potential results. We could also try the simulation in Algo trading to test the strategy in real time but without real transactions to trade. However, algorithms should only be deployed when they are completely secure.
In addition, risk management in algorithmic trading allows limits to be set at several levels. While some risks associated with technology and capital will remain, the rewards far outweigh the risks.
The future possibilities of Algo trading
Algorithms are nothing more than a brainchild of human beings. It can work on all possibilities a human mind can think of. Algo strategies are designed with market behavior in mind, including volatility and uncertain conditions. It is important to understand the strategy and deploy it according to market conditions using back-testing and simulation tools. Algo trading allows you to switch from one strategy to another depending on market conditions.
With the use of the latest technological tools such as artificial intelligence and machine learning, and the use of big data, Algo trading is poised to further revolutionize trading. In developed markets today, algorithmic trading’s volume share is around 70-80 percent, while in India it is around 50 percent. In the coming years, Algo will capture market share of over 95 percent with volume increasing several times. The future of trading is therefore Algo and Algo is the future.
(The author is Deputy Chairman of the Association of National Exchanges Members of India or ANMI. His views are his own)