What is Algo trading?
Algo trading is the short form of algorithmic trading. This is a method of trading in which trading is done by feeding instructions with the help of algorithm in computer software. In other words, in this method of trading, some instructions are fed into the computer software by programming which tells it at what price to buy the stock and at what time to sell it. It can be used for all types of assets such as stocks, bonds, commodities and currencies.
Algo trading was first introduced in India in 2008. In the initial days, it was limited to only big institutions, mutual fund houses and big brokers, but as its popularity grew with time, its doors were opened to common traders as well.
The main function of algo trading is to automate trading and execute trades without any human intervention. Through the given instruction set, the algo software can place orders, set stop loss, analyze market data and do many other tasks. There is no room for human emotions in this because all the work is done according to a set of rules and instructions.
Algo trading has gained a lot of popularity in India in the recent past. It works as per the guidelines set by SEBI and is capable of executing a large number of trades in a short period of time.
How to do Algo trading?
Unlike normal trading, in algo trading, buying and selling is done through computer software which is programmed by an instruction set. It includes the following steps:
Strategy Development: Intraday traders use technical analysis to trade in the market and algo trading also works on this basis. In technical analysis, buy and sell signals are generated on the basis of price movement, indicators, support and resistance, price patterns etc. All these methods are converted into strategies so that any trading decision can be taken.
Coding: Once the strategy is developed, it is converted into programming language so that the algorithm software can understand and execute it. For this, programming languages like python, c++ are used.
Backtesting: Backtesting means testing a strategy based on the historical price movement of a stock before actually using it in trading. This gives the trader an idea of whether the strategy will work or not.
Risk Management: Before stepping into any trade, it is very important to know about the risks and losses involved in it and this is what helps you in becoming a good trader. In algo trading, along with the strategy, necessary code is also developed and implemented for stoploss, position sizing and risk control.
Executive Platform: To run an algo trading program, an API and a good trading platform are required. API means Application Programming Interface which is given to brokers by SEBI. Through this, brokers are able to access real-time market data which is required to run the algo trading software. You can do algo trading by running your strategy on the trading platform provided by the brokers.
Algo trading software
Seeing the popularity of algo trading, SEBI has given the right to brokers to offer their API based software on which algo instructions can be fed to traders. There are many algo trading software available in India, some of which are mentioned below:
- Zerodha Streak
- Algo Test
- RoboTrader
- Tradetron Tech
- quantitatively
Benefits of Algo trading
Speed and Accuracy: The biggest advantage of algo trading is to execute trades quickly without any mistakes. Share prices change very rapidly in the stock exchange and due to this traders are often unable to enter a trade at the right price. Because algo trading is done by a computer software, it works in milliseconds which is not possible by any human being.
Emotionless Trading: In trading, a person often takes wrong trade due to emotions or can make a mistake in any trade but this is not possible in algo trading. It takes a decision only on the basis of the given instruction set and if that condition is not fulfilled then there is no possibility of taking the trade.
Diversification: In algo trading, many trades can be executed simultaneously which is not possible for any common trader.
Disciplined Trading: In algo trading, the trade is executed only when the conditions of the instructions given in the computer program are fulfilled. A common trader can lose his discipline due to market FOMO and can make a loss by making a mistake in trading, but in algo trading the possibility of this is negligible.
Back-testing: In algo trading, the strategy can be backtested on an old database before actually using it. This back-testing can save us from losing money in actual trading.
Disadvantages of Algo trading
Complexity: To do algo trading you must have knowledge of programming and coding. If you are not aware of this, then you have to pay money to someone else to get this work done and in case of any problem, you are not able to take any action yourself. This aspect of algo trading makes it complex for the common trader.
Technical Cost: To do algo trading you must have a good system and software. Apart from this, maintenance, good internet and backup also increase your trading cost to a great extent. Therefore, it becomes difficult for a small trader to do algo trading.
Lack of flexibility: The stock market does not always remain the same and its trend always keeps changing. Algo trading works well in trending markets but it does not work well in sideways markets. In such a situation, there is a risk of repeatedly hitting stoploss in trade because the market does not have a clear direction.
Technical Issues: Algo trading completely depends on computerized systems. If there is any kind of problem or technical issue in the system, there can be a loss in the trade and a good trade can be lost.
Impact on the market: In algo trading, many trades can be executed simultaneously, due to which there can be more volatility and liquidity in the market. This volatility can cause losses for many traders.
Future of Algo trading
As technology is advancing in the present times, algo trading can be widely used in the future. Being a new technology, it is currently limited to big institutions and traders as it increases the cost of trading to a great extent. But one thing worth noting here is that with the advancement of AI, we will not need to learn programming or any other skill, so in the future, you will be able to write code according to your strategy without depending on anyone else.
Apart from this, platforms like Zerodha Streak provide the facility to create trading strategies and use them in trading even without any coding knowledge. It is expected that in future the cost of algo trading will also reduce and small and common traders like me and you will also be able to take advantage of it.
Conclusion
There is no doubt that algo trading will emerge as a new way of trading in the future. While currently it is used only by a few people, the time is not far when it will be used by all traders. It is also important to note that SEBI has been coming out with guidelines from time to time regarding algo trading and only time will tell what impact it will have on the future of algo trading. We hope that this article has given you complete information about algo trading, but if you still have any question in your mind, then you can ask us in the comment section.
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