Technology is continuously transforming the world of retail trading. Nowadays, algorithmic trading, also known as algo trading, is rapidly reshaping the trading landscape. In short, algorithmic trading is a method of carrying out trades automatically using advanced mathematical models and computer programs. This technology provides several advantages over traditional methods of trading securities, such as speed, cost savings, accuracy and increased liquidity. In the following sections, the advantages of algorithmic trading will be explored, along with its possible implications on the securities trading industry.
Advantages of Algorithmic Trading
- Speed: One of the most prominent advantages of algorithmic trading is the speed with which it can execute trades, outperforming manual trading drastically. Automated trading works by instructing a computer to monitor conditions in the market and then enter or exit trades based on those preset conditions. This process takes milliseconds to complete, whereas manual trading would take much longer. As such, algorithmic trading is especially beneficial in highly volatile markets or those involving significant amounts of money.
- Cost Savings: Algorithmic trading requires a relatively low capital investment, as compared to traditional trading methods. This is due to the fact that the software and hardware required for algorithmic trading are typically less expensive than the fees associated with manual trading. In addition, computer programs do not require salaries or other personnel fees, unlike manual traders, which can further reduce trading costs.
- Accuracy: Algorithmic trading systems are capable of executing orders with absolute precision, as long as sound parameters are provided. This allows them to observe and execute multiple orders simultaneously, and with a high degree of accuracy. This is especially beneficial in complex trading strategies, where manual intervention is prone to error.
- Increased Liquidity: By providing an efficient and cost effective platform for executing orders, algorithmic trading facilitates liquidity in the market. This is due to the fact that computer programs can monitor market conditions in real time and execute trades at the optimal moments. As such, algorithmic trading can help to reduce spreads and promote higher trading volumes in the market.
Implications of Algorithmic Trading
- Reducing Opportunities for Human Intervention: Algorithmic trading has several implications for human traders and financial services companies. As algorithmic trading systems become increasingly sophisticated, the need for manual intervention in the markets is becoming increasingly obsolete. This is especially true in the areas of risk management and analysis, where software programs can easily be employed to make decisions faster and more accurately than human traders.
- Increasing Prevalence of High Frequency Trading: High frequency trading (HFT) is an automated trading system that uses high speed computers to execute thousands of trades in a very short span of time. This type of trading is becoming increasingly popular as algorithmic trading systems become more sophisticated and capable of executing trades in a matter of milliseconds. In addition, HFT is often employed as a market making strategy, as it is capable of generating large profits in a matter of seconds.
- Diminishing Returns for Brokers and Exchanges: Algorithmic trading has implications for brokers and exchanges as well. Previously, brokers and exchanges had a monopoly on the market, as they were the only ones capable of executing large orders on behalf of their clients. With algorithmic trading, however, clients can now bypass brokers and execute large orders directly with the exchanges. This reduces the fees associated with trading, as well as the commissions paid to brokers.
Algorithmic trading is also rapidly reshaping retail trading, offering many advantages to both retail traders and financial services companies. By providing a faster, more accurate and cost effective way to execute orders, this technology has significantly impacted the way in which markets operate. It has also diminished the need for manual intervention and put pressure on brokers and exchanges, as institutional and retail traders alike now have the capability to bypass them and execute any order directly with the exchanges. The implications of this technology will continue to have an impact on the securities trading industry for years to come.