In the stocks and commodities trading world, there are numerous financial instruments traders use to maximize their profits. From predicting market prices in futures to margin trading, there is more one way to trade. One of the most unique yet controversial financial instrument is algorithm trading.
What is Algorithm Trading?
Popularly known as Algo trading, algorithm trading is the process of using programmed computers to place market orders and execute them on your behalf. Traditionally, traders do the research, select markets and follow prices to execute at the right time.
Unfortunately, prices change so fast at times that it becomes humanly impossible to execute the perfect trades when you want to. Fortunately, with computer software programmed to execute trades based on your commands, it’s possible to maximize profits.
Commands used by Algo Traders
A program can be engineered to execute commands based on how prices change. Take the examples of commands noted below.
- Buy 1000 shares of a stock or cryptocurrency if its monthly average goes above its three-month average
- Sell 1000 shares of a stock or a cryptocurrency if the price leads to a profit or 1% or higher
- Sell 1000 shares if the average price for 60 days go below the average price for 200 days
There are numerous Algo trading machines that can be programmed in any set of way. Once set up, you don’t have to follow the markets any longer as the program will execute every trade as you programmed it.
Types of Algo Trading
There is also more than one type of Algo trading program. Below are some of the popular types of Algo trading programs.
Arbitrage trading involves taking advantage of slight price differences in two different markets listing the same share, commodity or cryptocurrency. If one stock exchange sells Dell’s shares for $2000 and the second exchange sells the same shares for $2004, you can buy the Dell shares where they are cheap and sell them in the more expensive exchange.
While it looks easy, the slight price differences change swiftly, sometimes in a matter of seconds. To capitalize on them, there are Algo trading programs specially designed for this kind of trading.
A scalping Algo program looks for opportunities where there are traders bidding for shares at a higher amount than sellers’ asking prices. Let’s say Jane sets her asking price for Dell’s shares at $2000 and a willing buyer, Mark, places a bid of $2000.10.
For some reason, Jane has not seen Mark’s bid that could give her a profit of 10 cents. She is probably not keen to see it. With a Scalping algorithm machine, you can buy Jane’s shares at $2000 and sell them with for $2000.10. Assuming Jane was selling shares worth $200,000, your program’s swift trade could earn you a profit of $100 minus any transaction charges.
Some algorithms are programmed to execute orders based on market predictions. They are designed to predict future market prices based on traders’ behaviors in the past, the present, and other important data. Predictive Algos can further be categorized based on their services:
- Fundamental Analysis
- Following trends
- Mean reversion
- Re-balancing portfolios
- Recognizing chart patterns
Read this article to learn more types of Algo trading.
Benefits of Algo Trading
Algo trading is a reality, and some traders have made millions using the right Algo trading programs. Here are some of the benefits.
Trades are Executed at the Right Time
In the world of trading, timing is everything. The speed at which an algorithm executes trades determines how profitable you become. A good trading program will execute your trades at the right time to maximize your profits.
Trades are Executed at the Best Possible Prices
It doesn’t always happen, but Algo trading programs are better off at executing trades at the best possible prices compared to traditional trading. Sometimes the best time to make an arbitrage move will last 15 seconds in the midnight. You can trust an Algo trading to make a move at the right time, thereby increasing your profits.
Trading stocks and cryptocurrencies as a day trader can be hectic. One minute the price will be in your favor, and the next minute the prices are plummeting. If you become emotional and trade based on speculations, you are likely to make errors that will lead to losses.
By contrast, software programs are not emotional. They execute orders based on your commands, which in turn reduces the human errors you would probably make trading manually.
It’s easy to retrieve data from Algo trading programs for evaluation. Since they follow commands, you can easily backtest the strategies and decide to continue using them or change your strategies. You can also use more than one Algo trading machine and use it to compare your trading progress.
Is Algo trading a Scam? Can you lose Money?
Algo trading is a legitimate financial tool and not a scam. However, algo trading is not accurate science. You can lose money using Algo trading tools. Here are some of the reasons as to why not everyone who tries Algo trading succeeds:
- Huge Swings
Stocks and cryptos can be volatile. If your trading tool is programmed to execute orders immediately a crypto losses value, you could make losses in the long-term.
- Huge Competition from Institutions-
Trading tools differ in the speed at which they execute orders. There is always some latency with cheap tools. And because institutions use the best tools available, they execute orders before you even have a chance.
- Trades Manipulation
Although illegal, some hedge funds and institutional traders create false demand for stocks and cryptocurrencies. They will send numerous orders to create psychological welfare among retail traders. The prices may move down suddenly, and programmed tools execute orders. Later on, the false demand disappears, and the institutional traders sell their stocks at huge profits.
Algo trading programs do not detect such manipulated trading, which misleads them into making unintended executions.
Algorithm trading is a common practice among day traders of stocks, cryptocurrencies and commodity markets. There are numerous reports of traders who have made millions trading with algorithm tools.