Thursday, 7 February 2019

What Is Algorithmic Trading? – Advantages & How It Works?

The technological developments, especially in the field of the stock market in India has no doubt revolutionized the way trading is done. From entering your own stock trades on the desktop or laptops to buying and selling the shares through the stock market apps, technology has indeed helped the people to invest easily.
One such technology that is proving to be a great blessing in disguise for the people is known as the algorithmic trading. A large percentage of investors in India, use the specially designed algorithm software to execute trades, take advantage of the favorable market conditions and most importantly get better returns. In a report called “Global Algorithmic Trading Market 2018-2022” published by the Research and Markets, the figures are quite surprising. It has been mentioned in the report that 30-50% of the trades in India are carried out through algorithmic trading. The trade is executed by using the software, which is generally offered by the brokerage firm or the third party providers.

Meaning of Algorithmic Trading?

An increasing number of people nowadays use computer software to trade in the stock market automatically. Algorithmic trading is essentially an automated trading system. Here the orders are executed automatically by the computers on the stock exchange through the software or code that has been programmed by the user. In simple terms, it is nothing but the automatic submission of the trades to an exchange by the computer program where the role of the humans is minimum or not necessary. It is also known by the name automated trading, black-box trading and algo trading. One of the most common algorithmic trading, which is used in India is called Python Application Program Interface (API).

How Algorithmic Trading Actually Works?

Through the algorithmic trading, an individual by using the computer programs can look forward to trade in the stock market in India at speed and volume, which are generally based upon certain factors such as the share price and prevailing market conditions. Let us understand this much better with the help of the algo trading example.
Suppose, you provide the following inputs in the algorithmic trading software:
  • Sell 80 shares of a company if its price falls below the 52 week low.
  • Buy 80 shares of a company if its price reaches above the 52 week high.
If we look at the above scenario, then you have provided the trading instructions to the black-box trading software. Hence, if the shares of the company fall below the 52 week low, then in such a situation, the algorithmic software will sell the 80 shares automatically. Likewise, if the shares of the company reach above 52 weeks high, then the software will buy the 80 shares automatically. From this example, one this is quite clear that there is no need for any human intervention as the orders are placed automatically by the trading software. The biggest benefit for the trader here is he is not required to sit in front of the computer all the time and keep track of the live share prices.

Advantages of Algorithmic Trading

The prominent advantages of algorithmic trading are as follows:

Automated Trading

One of the prominent advantages of the algorithmic trading is that it automates the trading, which is no doubt extremely beneficial for the traders. By using this software, it is ensured that the trades are carried out at the right depending upon the current market conditions. It makes sure that the traders do not have to track share prices all the time and most importantly increase the chances of the good returns.

No Human Emotions During Trading

Human beings sometimes get enveloped by the emotions and because of this, they may take bad trading decisions. There are chances that because of the fear or greed, you may suffer a considerable amount of loss and repent later. However, the algo trading software does not understand the human emotions and executes the trade as per the inputs provided to it.

Algorithmic Trading Can be Tested Before Using

This is one of the biggest benefits of algorithmic trading as you can test the past performance or data of the algo software before actually using it. It is extremely useful for the trader as he can weigh the pros and cons of the software before running it or using for trading.

Minimizes the Time Spent on tracking Share Prices and Market Conditions

It helps the individuals a great deal when it comes to reducing the time, which is otherwise wasted on tracking the share prices and market conditions. The best part is that a lot of precious time is saved when it comes to trading multiple accounts or executing different strategies at one time.

SEBI Guidelines on Algorithmic Trading

There are some rules or guidelines that have been issued by the Securities and Exchange Board of India (SEBI) when it comes to using the algorithmic trading software. The guidelines are as follows:
  • The traders or the stockbrokers must make it a point to get the necessary approval or permission from the SEBI before using the algo trading software.
  • There may be the situations when the stock market regulator i.e the SEBI may seek the prominent details of the algorithmic software for the purpose of any investigation.
  • The traders or brokers are required to get the audit of the algorithmic trading software done every six months.

The Last word

Algorithmic trading is one of the fastest growing technologies when it comes to trading in the stock market. Employing the right strategies and most importantly, providing the correct inputs to the software helps in taking the best investment decisions and get better returns. However, before using the algo trading software, ensure that you test it effectively because any faulty software can lead to a significant amount of loss. All in All, it can be rightly said that technology is redefining the way you trade in the market.

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