With the evolution of technology, many trading strategies have been evoked, leveraging the speed and accuracy of trading that a human can never meet. Algorithmic trading is one such trading model where computer algorithms enable the trade to meet predetermined conditions instead of humans. Traders write codes, setting trading instructions and accounting for different variables such as time, price, and volume, which are then executed by the computer system on behalf of the trader. A trading model like algorithmic trading eases the trading process and brings speed and precision to your trade.
What Is Algorithmic Trading?
Algorithm trading, popularly known as algo trading is a trading strategy that utilizes computer resources to make trading decisions, traders insert pre-written rules and conditions as codes into the computer system, and the computer then executes the trade on behalf of the trader once the conditions are met.
Combining computer programming and the financial market, Algo trading generates profits at great speed and frequency that a human trader can never make. Conducting trade based on time, price, quantity, or any mathematical model, this trading strategy makes the market more liquid and trading more ordered, which are often ruled out by human emotions in a human-assisted trade.
With computer access, crypto market knowledge, network availability, and coding ability, you are set to start algo trading. This trading model is mainly used by investment banks, mutual funds, pension funds, and other financial institutions with large orders for execution which are impossible or time-consuming for humans.
Advantages Of Algorithmic Trading
Since algorithmic trading utilizes computer programs they are more accurate and precise and offer high speed. The major advantages of Algorithmic trading include,
1. Reduce Market Impact
With algorithmic trading, assets can be bought and the impact of the purchase on the market can be checked instantly, reducing the number of transactions required to complete the trade and the time taken to complete the transaction, thus avoiding significant price changes.
2. Enhanced Accuracy
Enabling trade using predetermined conditions, computer programs offer systematic trade with great accuracy, eliminating the risk of human errors while placing the order. This trade often utilizes historical and real-time data to deliver the most precise trade.
3. Eliminates Emotional Decision Making
Since trading takes place under predetermined conditions, there is no room for emotions or psychological factors which often negatively affect the trade. Adhering to a set of rules, algorithm trading eliminates chances of risks like a bull market frenzy.
4. Reduced Transaction Cost
Since algo trading reduces the number of transactions and time taken to complete a trade, it indirectly helps in reducing the transaction cost.
How Does Algorithmic Trading Work?
The working of Algorithmic trading is simple, a computer program will evaluate the market price and place buy and sell orders on meeting the predetermined conditions. The algorithm trading system automatically monitors live prices and graphs to identify the appropriate trading opportunity and place orders, eliminating the need for traders to monitor these values, which can be sometimes overwhelming and tiring.
Limitations Of Algorithmic Trading
Though algorithmic trading strategies have numerous benefits they are not devoid of limitations. The major limitations of Algorithmic trading are listed below.
1. Missed Opportunities
Algorithm trade only functions under a predetermined set of rules, if the trade doesn’t exhibit any of the conditions, it doesn’t place a trade, missing the trading opportunity. However, by adding more indicators traders can mitigate this limitation.
2. Increasing Market Volatility
Large algorithmic trade can impact market prices, bringing losses to traders who are not able to meet up with these changes. This can lead to market volatility and even market crashes.
3. High Capital Investment
The setting of codes and their implementation can be costly, and the maintenance also involves costs, making many back off from using the algorithmic trading option.
4. Limits Customization
Operating on the predetermined rules limits the ability of traders to adjust the trade according to their needs. The lack of utilizing qualitative and subjective factors that can influence market movements affects traders who prefer an instinctive trading approach.
Also Read: Beginner’s Guide To Essential Crypto Trading Strategies
Bottom Line
Algorithmic trading utilizes computer programming and market data to offer high-speed and precise trade that is nearly impossible for human-driven trades. It collects historical and live data and executes trade on meeting the set of conditions, easing the trading process. However, executing a trade only on predetermined conditions can limit the advantage of reflexive trading. It solely depends on the trader whether to choose algorithmic trading or be comfortable with their own trading strategies.
