You’ve probably heard about “high frequency trading”. But you may still have question in mind ‘What are algorithmic trading methods?’ Trading algorithms are pieces of software that buy and sell stocks on your behalf at lightning speed – sometimes up to 200 trades per second. They’re often tailored by hedge funds and investment banks for specific investment strategies like value investing or momentum investing and can be worth millions of dollars.
What do these algorithms do? Anything you want them to! They trade through a broker like E*TRADE or TD Ameritrade. And, they buy or sell stocks using your account balance as their source of capital.
Basics of Algorithmic Trading: Concepts & Examples
By using quantitative models and complex calculations, computers can make high-volume trades in fractions of a second, taking advantage of split-second market opportunities while minimizing risk. Algorithmic trading is not the same as ‘high frequency trading’ – but many traders employ both strategies.
Here is an example of what some software programs used for algorithmic trading might look like:
This program is smart enough to look for larger trends in the market and respond accordingly; so, if it notices a sudden price increase for stock ABC, it will automatically buy more shares with your money. But, it will sell off shares of stock ABC as soon as it notices that the trend has reversed.
While this may sound simple enough, remember that this program is capable of processing large amounts of data – and making decisions based on its findings – at machine-gun speed.
How it Works: Step by Step
- The software scans all companies listed on a stock exchange and uses an algorithm to select its trades. Each algorithmic trading strategy is based on an algorithm. The algorithm can be as simple or complex as you want it to be. Complex algorithms are used by professional traders who have in-depth knowledge about financial markets; simple ones might just follow strong trends in the market with your money behind them.
- The software is linked to your brokerage account and automatically places buy or sell orders through it. Once the trading strategy is set, the software goes out and tries to find stocks that match those criteria – it uses the information you have already provided (like price, expected volume, momentum) and uses that as a filtering tool. The program can also be used to place stop-loss orders on a regular basis.
- Every time a trade occurs, an email is sent to its owner notifying them of the change in their account status and what they should do next. You can get the full explanation of what happened and decide whether you need to make any changes to your strategy.
- Repeat steps 1 through 3 until a profit is made or your account is depleted. At this point, you can either close the program or restart it with a new trading algorithm; and start trading again – the choice is yours!
Benefits of algorithmic trading
The benefits of using an algorithmic trading software program are obvious. The software makes money for its owner by devoting all its resources and processing power to analyzing financial markets and executing trades. Anyone, from professional traders who already have a lot of market experience, to beginners who don’t know much about financial markets but want to be able to profit from them can use it.
You can also use it as a way to diversify your portfolio. it is because algorithmic trading allows you to invest in more than one stock at a time. This can also help you manage your risk better since you’re not putting all your eggs in one basket. If a particular stock begins showing unfavorable signs, the program will automatically sell it off, keeping your losses to a minimum and maximizing your potential profits.
The Lightning Speed of algorithmic trading: Explained
Modern technology makes it possible to execute trades in microseconds, so even the smallest opportunity can be taken advantage of. As you’ll remember from the example above, each trade executed by a trading algorithm is done as quickly as possible after it has been triggered.
Imagine, a trading algorithm is running on your behalf and has detected a sudden increase in price for stock ABC. It will place a buy order for 500 shares of stock ABC at that moment. And it will close its position as soon as it pushes your account balance over $50. To do this, it will need to open 500 orders with your broker’s servers – all within microseconds.
How Much Can Algorithmic Trading Make You?
As you can see, algorithmic trading can make you a lot of money – but it will take some time. This is because these programs have to analyze and examine hundreds of variables before they execute a trade. With time and experience, however, you’ll be able to do this too; and eventually be able to make even more money with them!
How much money you make with algorithmic trading depends on your knowledge and experience with financial markets; this will also determine how large your risk is.
Risks involved in algorithmic trading
Algorithmic trading is not completely risk-free, however. One huge risk is that the program can be hijacked and used to execute trades against its owner’s will. This kind of activity, called ” HFT – High Frequency Trading fraud” is usually committed by professional high frequency traders who want to take advantage of less-informed retail investors for their own benefit.
As a rule of thumb, you should only allow well-known financial institutions you trust (like E*TRADE or TD Ameritrade) to manage your algorithmic trading activities. This way you can rest assured that their goal is to work in your best interests and make sure you don’t lose money through these programs.