What is algo trading?

Algo trading is algorithmic or automated trading, which refers o automated trading done by a computer without any human interference.Imagine! How much science and technology has progressed that even trading can happen using computers. Algo trading is free of any human emotional or impulsive bias for buying and selling shares. Algo trading is usually used for High-frequency trading (HFT), where multiple orders are placed across varied markets by giving pre-programmed instructions. Using algo trading, the market reach gets expanded, and the possibility of earning profit increases manyfold.

You can trade in derivatives, equities, currencies or commodities using algo trading. Algo trading has been much in talks off late due to the huge convenience that it brings. By using algo trading, your market reach increase, and the trading is done at a fabulously high speed due to computer programming. The use of this trading is increasing day by day and currently accounts for 35-40% of stock trading. Algo trading is done using software which is provided by a third party provider or by a brokerage firm.

For retail investors, though algo trading throws immense opportunities, yet, it is not a viable option as it requires a separate server which is very expensive. In India, you would find most hedge funds and investment banks using algo trading to maximize profits.

How does Algo trading work?

Algo trading involves an algorithm which is a set of instructions given to a computer to perform a designated task. The computer is fed with pre-programmed instructions to trade with great accuracy and speed, which cannot be performed by a human being.

Algo trading involves both fundamental as well as technical analysis of stocks. The technical analysis involves mathematical functions that are built around volume, price, and time. The fundamental analysis works around various facts such as the ethics of the company, policies for shareholder, the underlying beliefs, principles, and values of top management, the competitive advantage, the industry growth, government support, etc.

A broker can feed in all the details about technical as well as financial analysis in the software using which the software functions as desired.

Though algo trading looks very promising, yet, it is under observation for some time now. It is believed that some traders still have unethical access to trading information and data. So, to overcome any possible fraudulent, the system for algo trading has been strengthened and iskept under strict supervision.

Algo trading is a trading strategy which is surely not aimed at long term investment. Though, it would be great if retailers also participate in this, yet, the technology is not accessible by most retailers and small-time investors. A point to note here is that algo trading makes the stock market highly volatile if there is a small depression in pricing or one negative news outbreak then it may trigger a mass sell order or may even lead to a market crash.

You would find some stock brokerage firms offering algo trading as one of their products. To encourage participation by retail investors, there were rumours that SEBI will come up with supporting regulations and guidelines for them. However, nothing has been confirmed on this front yet. Algo trading has not been made foolproof yet, just like any other successful system. The trader’s own investment wisdom, judgment, and financial management will be of great help to determine a successful investment strategy.