Manual trading in the stock markets has many limitations. In a highly volatile market, placing orders manually can result in a great deal of slippage. There is also the issue of making emotional and impulsive trades driven by human biases rather than concrete data. You can opt for algo trading instead to work around these inherent constraints.
What is algo trading, and how can you use this technique? In this article, we will take you through the meaning of algo trading, the various algo trading benefits, and the different strategies you can use to automate your trades.
What is algorithmic trading?
Algorithmic trading or algo trading is the process of using pre-programmed computer codes and sets of instructions to enter and exit positions in the financial markets automatically. In simpler terms, it involves using computer commands to execute trades when certain conditions are met. The conditions can pertain to various parameters like the stock price, trading volume, technical indicators, etc.
Algo trading eliminates the need to place orders manually, thus saving you a great deal of time. In particularly volatile market conditions, using algorithms to execute trades helps you take advantage of price fluctuations. The best part is that you don’t have to be an expert coder to engage in algo trading. Many free and paid API tools are offered by stockbrokers and fintechs today. You can use these solutions to automate your trades without any prior coding or programming knowledge.
Strategies for algo trading
If you are a seasoned trader, you may already be familiar with various manual trading strategies. Many of these techniques can also be used in algo trading. Let’s take a closer look at how to do algo trading using some popular trading strategies.
- Mean reversion
Mean reversion is a strategy based on the assumption that every asset has a mean or average price — and that its market price will converge or revert to this mean price over time. You can use algo trading to leverage the temporary highs or lows of an asset before its price reverts to the mean range. - Scalping
Scalping is the process of making multiple trades in the same asset within a short period to profit from minor price changes. When done right, it could result in numerous small profits that add up to significant gains. Scalping works best in highly volatile markets, and algorithmic trading helps you execute trades swiftly in such uncertain conditions. - Arbitrage
The arbitrage trading strategy involves selling and buying the same asset in different market segments to take advantage of the minor price differences between the two. With algo trading, you can identify opportunities for arbitrage and take advantage of them promptly before the prices align in the two market segments. - Momentum trading
Momentum trading works best when there is a strong and definite trend in the market. You can capitalise on this trend and exit your position when a trend reversal occurs. Algorithmic trading makes it easier to identify such strong trends and exit at the point of trend reversal efficiently. You can integrate technical indicators into the algorithm to exit the trade at the right time. - Index fund rebalancing
Index funds are required to align their asset portfolios to match the benchmark index they track. As a part of the rebalancing effort, these funds may sell or buy stocks and securities in large volumes, creating minor market trends. With algorithmic trading, you can identify such opportunities and leverage them to make quick profits.
Benefits of algo trading
Now that you know what algo trading is and how to do algo trading using common trading strategies, let’s take a closer look at the top benefits of algo trading. These benefits include the following:
- High-speed execution of high-volume orders
- Reduced transaction costs in the long run
- Immunity to sudden price changes since the orders are executed in milliseconds
- Automated and highly accurate trades that are not prone to human errors
- Opportunity to take advantage of rapid price fluctuations in the market
Conclusion
You need the right platforms and tools to fully leverage the many algo trading benefits. Today, many leading stockbrokers offer algo trading apps to help retail traders automate their trading strategies. However, before you use these tools, you must become well-acquainted with how to do algo trading in different market conditions.
