Investors are constantly on the lookout for new investment strategies that take the guesswork out of an investment. They want it to be a high-yielding, low stress approach; one that minimizes risks and maximizes profits on every deal. Algorithmic trading systems were developed along these lines. “Algorithmic” sounds like a heavy term to digest, but it is not. We will give you a brief overview of algorithmic trading and its varied types.
What is an Algorithmic Trading System?
The term automated trading is used interchangeably for Algorithmic trading. However, the two are different concepts. The latter is a subset of the former. Algorithmic trading is defined as the use of advanced mathematical tools to make important transactional decisions in the financial market. This system relies heavily on computer models to make trades. Based on the prevailing market conditions it decides whether to buy, hold or sell a position.
It splits a large trade into multiple orders in order to reduce market impact.
Algo-trading is generally used by large institutional investors. Many hedge funds and banks have built their own algorithmic trading systems. These systems are complex and they vary from one broker to another. It is also known by some as black box trading and algo-trading. There are many Algorithmic Trading Systems for individual traders and investors available online.
The algorithmic systems have several advantages to an investor. It involves minimum human intervention. It is technology driven and hence offers a higher level of accuracy. It is automated and capitalizes on every possible opportunity that arises in the market. It is prompt and spots high probability opportunities even before a trader couple ever spot and reaction to a setup. It has greater benefits for large institutions because they deal in a large amount of volume each day which requires accumulation and distribution to avoid moving the market bid and ask price.
There is another term that is very popular on Wall Street. It is High-Frequency trading. High-frequency trading is a subset of algorithmic trading. It is used to refer to short term trades. It is an electronic platform that trades large volumes at very high speeds.
Types of Algorithmic Strategies
Algorithmic trading systems are categorized into different types based on the functions they perform. Listed below are the major types.
- Trade Executions Algorithms:
This strategy is applied to minimize price impact when executing trades. It breaks up trades of large volumes into smaller orders and releases them slowly into the market.