What is Algorithmic Trading and How Does it Work?
Algorithmic trading, also known as algo trading or automated trading, refers to the use of computer programs to fire trades in a broker platform. These tools use pre-set rules and parameters to decide when to buy or sell scrips such as stocks, bonds, currencies, and commodities.
Algo trading has become very popular in recent years, as it offers several benefits over normal manual trading methods. One of the key benefits is speed - algorithms can make decisions and execute trades much faster than a human trader, allowing for quicker reaction times to changing market conditions.
Another advantage of algo trading is the ability to backtest and optimize trading strategies using historical market data. This allows traders to identify patterns and refine their strategies before deploying them in live trading environments.
To activate algorithmic trades, traders usually use special software platforms that allow them to write and test their own programs.
The basic process involves the following steps:
Data collection: Algo collects real-time market data on the financial instruments it is trading.
Analysis: The algorithm uses pre-set rules and parameters to analyze the data and identify potential trading opportunities.
Decision-making: Based on the analysis, the algorithm makes a decision to buy or sell a particular financial instrument.
Order execution: The algorithm sends an order to the market to execute the trade.
Monitoring: The algorithm continually monitors the position and market conditions, making adjustments and executing trades as necessary.