Reviewed by Oct 05, 2020| Updated on
Algorithmic trading is a procedure for carrying out orders using pre-programmed and automated trading commands to account for factors such as volume, timing, and price. An algorithm comprises a set of instructions in order to solve a problem.
Often, algorithmic traders utilise trading technology of high-frequency enabling them to make a significant number of trades in a second. Algorithmic trading can be utilised in several scenarios such as arbitrage, execution, and trend trading strategies.
Mostly, algorithmic trading is utilised by big brokerage houses and institutional investors with an aim to bring down costs related to trading. Research has proved that algorithmic trading is beneficial especially for order sizes which are large in size i.e. they might comprise almost 10% of the entire trading volume. Generally, market makers utilise algorithmic trading to create liquidity.
Highlights of Algorithmic Trading: 1. Algorithmic trading is a process wherein algorithms are used to employ strategies to carry out trades. These algorithms are based on procedures and rules. 2. Large trading firms and institutional investors use it for a wide range of purposes. 3. It's popularity has grown significantly since the early 1980s. 4. It renders advantages including faster execution time and reduced costs. 5. It's disadvantages include exacerbating the negative tendencies of the market by resulting in flash crashes and also immediate liquidity loss. 6. Traders have been developing algorithms which can depend on deep learning with an aim to make their businesses more profitable.
Algorithmic trading facilitates easier and faster execution of commands, making it reliable for exchanges. On the other hand, this means that investors and traders will be able to quickly book profits off minor changes in price.
However, algorithmic trading has a few advantages too. One of the disadvantages being, it leads to instant liquidity loss.
Algorithmic trading uses complicated formulas which comprise both human oversight and mathematical models for making decisions related to buying or selling financial securities over an exchange.