Advantages of Algo-Trading

​Beginner online traders believe stock and currency price movements are random and unpredictable. Some even believe trading is akin to gambling. But, unlike gambling, traders can stack the odds in their favor. By analyzing the market and executing based on a predetermined set of conditions, millions of traders are making a living out of it.

Algorithmic trading, also called black-box trading, automated trading, or algo-trading, uses sophisticated computer programs to execute trades. First, the trader sets parameters or things that must happen on the market for a trade to go live. The parameters could be as simple as buying Apple stock if the stock price reaches $102. Then sell the stock (exit) when the price rises to $115 or drops to $97.

If the trader wanted to buy one million Apple shares, buying it all at once may distort the market price and cause volatility. But, by breaking the shares into batches of 1,000 shares, for instance, and instructing the algorithm to sell every five minutes or at specific price levels until he's bought all 1 million shares, he can avoid distorting the price. The investor would also have to sell (exit) in batches. For this reason, algo-trading is more popular among institutional traders (people who trade lots of money) than individual traders.

Individual traders tend to trade manually using the same parameters but must execute the trade themselves. But they, too, can use algo-trading. Algorithmic trading is purely rule-based-decision making. This means there's no room for misinterpretation. Either a stock has been trending upwards for a week and has reached a predetermined price, thus executing a trade, or it hasn't, meaning no trading.

By taking emotions out of trading, algo-trading can increase the odds of success, given trading is mostly a psychological battle. Because the trader can predetermine and set conditions under which they would enter and exit a trade, profitable or not, algo-trading eliminates the need to interfere with trades once active.

In addition to removing human error, algo-trading also saves time. Investors who don't have the time to manually adjust exit points, especially when they have several active trades, use algorithms to trail the exits (reducing risk exposure and locking in profits).

One can instruct their algo to move the stop loss (acceptable risk) to their buy or sell price if it goes up or down by a certain value or percentage. This makes their trade risk-free. This way, they'd break even if the price suddenly moved against them. If it continues to move in their favor, the algo will keep trailing the exit, ensuring the trader makes some money, whatever happens.

Algo-trading is not without its fair share of disadvantages. For instance, automated trading is heavily tech-dependent. For one, it requires a high-speed internet connection for flawless trade executions. This overreliance on technology can result in missed opportunities in the event of a technical issue, such as an internet outage or software issue.

Algo-trading does not guarantee trading success. Neither can it accurately predict where the price will go. It makes entering and exiting trades seamless, especially when trading in high volumes. But because Algo-trading eliminates the human element in decision-making, traders who struggle to keep emotions out of their trading decisions can leverage it. Moreover, algo-trading works best when a trader already has a sound trading strategy.

Zi Qian Zhang, Real Estate

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