Basics Of Algo Trading: Concepts & Examples

Algo trading

In 2008, Algo trading arrived in India, although very few individuals were aware of it. It was created to automatically carry out numerous market trades at precise timing and speed, which is impossible for people to perform. Algorithmic trading commonly referred to as “Algo trading,” enables investors and traders to transact on the stock market by employing automated procedures.
Although not entirely new, algorithmic trading is still in its infancy in India. Ram Kalyan Medury, the founder and CEO of Jama Wealth, claims that SEBI Registered Investment Advisor algos, which have a variety of developed structures, regulations, and participants, contribute for 70 to 80 percent of the total market volume internationally. Algorithms, which are comparatively easy to use and little understood, are still only performing at 50–60% volume in India.
The use of algorithmic trading in India just began about 2010 and was initially limited to institutions and brokers. However, the retail market now has free access to constructing algorithms thanks to the expansion of digital discount brokers and API solutions, and the possibilities are unlimited.

What is Algo trading?

Now let us understand what is algo trading. The technique of executing market orders by using a pre-planned set of rules subject to price, quantity, and volume is known as algorithmic trading. Because an algorithm or formula with a predetermined set of rules is used to execute the trade, algorithmic trading is made possible. Algo trading’s goal is to help traders and investors execute trades quickly and accurately for greater returns. There is a substantial rise in the use of algorithmic trading platforms in India.
Due to the expansion of electronic trading platforms and the growing usage of technology in the financial sector in India, algo trading is getting more and more well-liked. Algo trading is widely used by traders and investors in India to execute deals more quickly and effectively and to take advantage of market opportunities that may be challenging to discover manually.

Algo trading meaning?

Algo trading meaning which is also known as automated trading, black-box trading, or simply algo trading, is the technique of employing computers that have been programmed to execute trades in a way that is faster and more frequent than a human trader could ever do.
Although you can create your own algorithm and use it to generate buy or sell signals, full automation is not allowed for retail traders, therefore manual intervention is required when placing orders.

What is algorithmic trading?

Now let us understand what is algorithmic trading , as we know in Algo trading, computer programming and financial markets are combined in algorithmic trading to carry out trades at precise moments.
Algorithmic trading aims to remove emotions from transactions, provides the best possible execution of a deal, instantly places orders, and might result in lower trading commissions.
Trend-following tactics, arbitrage possibilities, and index fund rebalancing are examples of popular trading methods. Additionally, algorithmic trading is carried out in accordance with trading volume (volume-weighted average price) or time (time-weighted average price).
You need computer access, network access, financial market expertise, and coding skills in order to begin algorithmic trading.
Different types of investors employ algorithmic trading for different reasons. This is why algorithmic trading meaning is important to know. Algo trading is used by institutional investors like mutual funds and pension funds to buy a lot of equities. It facilitates their trading without having an impact on stock price.
Algo trading increases liquidity, which benefits sell-side participants like brokerages. Systematic traders like hedge funds conduct trades that include taking opposing positions. In these circumstances, algorithmic trading is a more effective choice.

Algorithmic trading concepts?

High-frequency trading (HFT), which tries to profit from placing a lot of orders quickly across numerous markets and multiple decision parameters based on preprogrammed instructions, makes up a substantial portion of algo trading today.
After understanding the basics of Algo trading, let us now explore the concept deeper. Many different types of trading and investing involve the usage of algorithms, such as:
When mid- to long-term investors or buy-side companies—pension funds, mutual funds, insurance companies—don’t want to utilize discrete, high-volume investments to move stock prices, they use algo trading to acquire equities in bulk.
Programming their trading rules and letting the program trade automatically is much more efficient for systematic traders, such as trend followers, hedge funds, or pairs traders (a market-neutral trading strategy that matches a long position with a short position in a pair of highly correlated instruments, such as two stocks, exchange-traded funds (ETFs), or currencies).
Compared to strategies relying on the intuition or instinct of the trader, algorithmic trading offers a more methodical approach to active trading.

Basics of Algo trading

Let’s say a trader plays two calls, When a stock’s 50-day moving average surpasses its 200-day moving average, buy 50 shares of the company. (A moving average is a calculation that takes the average of previous data points to smooth out daily price volatility and identify trends.)
When the stock’s 50-day moving average drops below the 200-day moving average, sell any shares you still have.
A computer software will automatically monitor the stock price (as well as the moving average indicators) and place the buy and sell orders when the predetermined criteria are satisfied using these two straightforward instructions. The trader is no longer need to manually enter orders or keep an eye on live pricing and graphs. This is automatically accomplished by the algorithmic trading system, which accurately recognizes the trade opportunity.

After understanding the Algo trading basics, let us understand the trading methods employed in automated trading:

Trend recognition– The most popular algorithmic trading techniques rely on price level changes, moving average trends, channel breakouts, and other relevant technical indicators. Since these techniques don’t need making any predictions or price forecasts, they are the simplest and easiest to implement using algorithmic trading. Without delving into the complexities of predictive analysis, trades are started based on the occurrence of favorable patterns, which are simple and straightforward to apply through algorithms.

Opportunities for Arbitrage

The price difference can be used as risk-free profit or arbitrage by purchasing a dual-listed stock at a cheaper price in one market and simultaneously selling it at a higher price in another market. The same process can be used again because stocks and futures products periodically have different prices. Effective order placement and the use of an algorithm to detect these price differentials enable profitable opportunities.

Rebalancing of Index Funds

Index funds have designated times for rebalancing in order to put their holdings in line with their respective benchmark indices. This creates profitable trading opportunities for algorithmic traders, who profit from expected trades that, depending on how many stocks are in the index fund, provide returns of 20 to 80 basis points just before index fund rebalancing. Algorithmic trading algorithms are used to initiate such deals for quick execution and the best prices.

Conclusion

Algorithmic trading makes extensive use of quantitative analysis or modeling. As you’ll be investing in the stock market, you’ll need trading knowledge or past financial market experience. Finally, you’ll probably require knowledge with coding or programming because algorithmic trading typically makes use of technology and computers. High-frequency trading is made possible by algorithmic trading. In the past, milliseconds were used to measure high-frequency trading.
There are no rules or regulations that restrict the use of trading algorithms. Some investors may contend that this type of trading encourages an unfair trading environment that harms markets. It is not, however, illegal in any way.