What is Algorithmic Trading?

You might have heard the terms “Algo Trading” or “Black-Box Trading” from finance-related sources or videos. But what is this “algo trading”? Is it any good? And if so, why doesn’t everybody just do that?

As the name suggests, algo trading refers to using computer programs for trading. These programs use a pre-defined set of rules set by the person in charge and theoretically, are meant to execute in milliseconds should the set criteria meet.

The goal of algorithmic trading is to cut out human emotions out of trading decisions. You might have witnessed this yourself too: natural emotions that occur when we deal with money like fear, greed, regret, etc. get even more elevated when we trade our money, because there is a possibility to lose.

Using a computer to execute trades rules out problems that most humans would face and also helps execute trades at speeds no human can achieve. These trades are usually meant to capture a small number of points in the market, so they use large trade sizes, and due to that fact, also help provide a lot of liquidity in the market.

Computers can make however many decisions in a day and keep executing regardless of any profits or losses. On the other hand, humans can only make so many decisions in a single day. And mental fatigue aside, after witnessing two or three losses on the trot, you might not even want to trade at all, but a computer just won’t care.

But I don’t like to trust computers with my money, whatever the benefits. I’ve tested my strategies and developed control (most of the time) over my emotions. But there are many other reasons why many more people don’t use automated programs to trade in the markets.

• Black Swan Events: Sometimes big one-sided moves happen in the markets, which most market participants cannot predict. And computer programs need historical data to run, which also cannot predict these events. And these events can wipe out weeks of profits if the programs don’t know how to deal with situations like this.

• Latency in tech: Delay in execution in other words. Latency can cut profits in half and make losses bigger if the correct prices at the correct time are not gotten. The delay can also lead to missed trade opportunities, meaning another way to upset the PnL balance.

• Too much reliance on technology: While technology is a huge friend to all of us, any issues in the underlying tech or the support systems, like the internet, can lead to a lot of issues. And since there is no human element, controlling such situations would be very problematic.

• Costs: Maintaining and improving algorithms and hardware both take up a lot of time and money, a type of cost you can simply forego by trading yourself: you only need a computer and an internet connection.

Too many issues for my liking, plus I don’t know how to code very well. What do you think? Would you place your money in the hands of a computer (trained obviously) or are you on the sceptical side like me?

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