The use of algorithms can be found in many aspects of life such as a social media platform being instructed how to provide content to a newsfeed. It should not be too baffling to understand algorithms are used to trade stocks. An algorithm is simple instructions for a computer system to complete tasks. Trading with the use of an algorithm has a nickname called algo trading. Algo trading is completed via computer under the direction of coded instructions within the algorithms to execute stock trades. Stock trading with the use of an algorithm is expected to grow over 10 percent by 2020. In 2017, algo trading was responsible for 70 percent of the trade volume in the United States. There several algo trading Algo trading has been around since the mid-1980s. There will be a countless number of people who will continue to make use of algorithms because of the benefits it offers.
Advantages of Using Algorithm for Trading Stock
There are many advantages to gain by using an algorithmic trading strategies. It would eliminate the emotion involved in trading. The algorithm will execute based on instructions within the algorithm’s code in the same manner and each time when the trading market presents signals to do it. For example, an algorithm has been coded to sell a stock when the stock price increases by 5 percent, the trade would only be executed once the stock increase by 5 percent. The elimination of human emotion in stock trading is not the only benefit to using algo trading, and the other benefits are:
A faster and efficient method of stock trading
• Provides the discipline needed for trading
• Enhances diversification of stock portfolios
The use of a stock-trading algorithm allows a stock trader to execute a trade much faster than manually completing the trade. In some cases, and the trade would execute in milliseconds. Timeliness of the trade’s execution influential in determining the results of the trade. Since the market moves much faster with the use of algorithms, trading is more efficient. By implementing algo trading, it provides discipline to execute a stock trading plan and have traders stick to the plan. Many traders will veer from a stock trading plan from lack of discipline because of emotion caused by an abrupt change in the stock market. The use of an algorithm can improve the diversification of a portfolio. An algorithm can be programmed to search the stock market for stocks meeting the criteria to execute a trade especially when the trading platform allows the use of multiple accounts.
Types of Algo Trading Strategies
There are several algo trading strategies, but the more common types of strategies are trend following, arbitrage, and momentum. A trend following strategy will make use of trends in the market to trade stocks. Trends are determined by the various movement of stock prices based on technical indicators used in technical analysis of stocks. For example, an algorithm can be programmed to execute a trade based on stock’s 200-day moving average. The arbitrage trading strategy will use a price differential of dual-listed stocks to generate a profit. For example, if Stock A was brought on ABC Exchange for $10 and sold on the XYZ exchange for $15, it would net a $5 profit. The momentum strategy utilizes high-volume in a direction of the market that supports a trend to execute a trade. A momentum strategy is easy to implement.