What is Algorithmic Trading? How does it work? Everything you need to know about Algorithmic Trading.

Overview

Algorithmic Trading or Robo Trading, or Automated Trading, are the terms that are commonly used when we talk about Algo trading. The rational approach helps investors make better and more intelligent trading decisions using technical, analytical & strategies. With modern technology, we can build solutions that make algo trading more robust with proven strategies. Automate the trading and ease when to buy or sell without human interaction entirely based on algorithms. In this article, we will explore the details of how these algorithms work and the advantages and future of the algo trading platforms. This article is all about How Algorithmic Trading Systems work.

What Is Algorithmic Trading System

Algorithmic trading uses strategic algorithms to automatically make trades, create orders, and manage order submission without human interaction. Algorithmic trading uses technical analysis and conditional strategies to generate Buy/Sell signals. A combination of Trading Indicators or chart patterns used to formulate the strategy.

Charts Patterns: Chart patterns have specific, predictable values that are recognizable and repeatable on the stock price path due to Traders’ behaviour in the market. It helps traders to understand the market condition (Bearish or Bullish). The most well-known chart patterns are;

• Triangle Chart Pattern
• Wedges Chart Pattern
• Rectangle Chart Pattern
• Double top & Double bottom Chart Pattern

Trading Indicators: Trading Indicators are mathematical calculations plotted on the price path to help traders understand the market trend and make buy or sell decisions. Here are the most well-known Trading Indicators used by most of the Algorithmic Trading Systems (Algo Traders).

• Moving Average Cobelts
• Bollinger Bands
• Keltner Channel
• MACD
• Stochastic oscillator
• EMA
• Relative Strength Index (RSI)

These are some of the primary elements used in algorithmic trading (algo trade) Web/Mobile applications.

How does Algorithmic Trading System work?

There are different types of algo trading systems, but I think it is the simplest way to understand this complex system.

If it still seems too complicated, then no worry, I got your back. Let’s break it down into small steps;

#1 Create A Strategy: Creating a robust trading strategy is the most crucial aspect of the entire system. Getting a system that provides flexibility to build your strategy with a combination of indicators and mathematical formulas is always a Plus. You can create a robust strategy in two ways: First, Create on your own; if you have the experience or expertise, then you can build your strategy with the use of tools provided. But most of the time, you do not have the expertise to do such complex calculations or create a robust strategy. In that case, you can opt for a pre-built strategy that is developed and thoroughly tested by professionals, which can give you more value without putting much at risk.

#2 Testing: Whether it is your strategy or created by an expert, you should perform testing whenever you deploy any strategy on the live market. You can perform testing in two way:

Back Date Testing: Automate the trade on backdating. For example, test the strategy on a backdate range to see if you use these strategies then the profit/loss you could get.

Paper Trading: Test it on Live market data but not execute or create any actual order with your broker.

Your success with algorithmic trading mostly depends on testing after forming the strategy. If you test it Hard, then your journey will be smoother in the real market.

#3 Deploy on the live market: Once you are happy with the test result, and the strategy is looking promising to you, it is time to hit the real market. When you put your strategy on the live market, It starts scanning the selective stocks and functions the way strategy was formed.

#4 Signals: When your strategy finds any entry or exit point, it sends signals to the algorithm. The algorithm determines what type of signal it is. If it is a Buy call, then the algorithm creates a Buy order. If it is a sell call, then it makes a sell order.

Now hold for a moment and let me understand “ What is Create an Order?”, An Order is a set of information sent by Trader to Broker/Brokerage, Which contains information like Stock Name, Quantity, Order Type (MIS, CNC), Stop loss, Buy at Market/Limit, Validity, Target and many more. This information was pre-fitted at the time of strategy creation.

#5 Broker Connection All the Algorithmic Trading systems will ask you to connect with your Brokers API. It will allow algorithms to place an order on behalf of human traders. When Algorithm creates an order, It establishes a connection with your broker system and posts the order information using the broker’s API. Many brokers provide such API’s free of cost or with some additional charges.

#6 Execution: After establishing the connection and sending the order information, the algorithmic trading system sets on the wait until the subsequent trading signal triggers. You can also check the order status of your current order. There are Four Status for any order you created,

And this is how most of the algorithmic trading system works under the hood.

Type of Algo Trading platforms

1. Strategy Market Place: A platform where anyone can create their own strategy, test it and sell it on market.

2. Robo Advisory: A platform provided by advisory firms. Where an Experience Technical Analyst creates a strategy and closely monitors the performance.

Future scope of Algo Trading

2021 is all set for algorithmic Trading, and there is no doubt that people who have no idea or less experience with how to make an investment or how to do trading Algo trading will make it easy for them. We talk about technical aspects of Algo Trading then with the use of Machine Learning and AI. This system can be mighty and more robust in terms of performance & accuracy.

Conclusion

Algorithmic Trading is not a future, it is here already, and it is growing exponentially. It is benefiting the market as more and more people will go for investment and intelligent trading. If someone has no time to watch the market trends or focus on multiple stocks, Algorithmic Trading could be the best option. We do not recommend or provide any financial advice. This article is just to understand the technical aspect of the system.

References

[1] https://en.wikipedia.org/wiki/Algorithmic_trading

[2] Photo by Wance Paleri / Unsplash

We have more on Algorithmic Trading systems, but for this time, this is what we got for you. If you like it or don’t or have any suggestions, please let us know by contacting us through contact or our social media handles. See you next time !!! ❤️