All about algorithmic trading
The new buzz word among the securities market enthusiasts is ALGORITHMS. Traders across the globe have been affected by the use of algorithms. Positively, if they are doing and obviously, on the negative side if they are not into it. Algo, or system trading (as is known by many in the market place) has been in vogue since quite some time in developed financial markets while developing ones (yes, I use this classification for capital markets as well) are awakening to this concept gradually. Not many participants still know what it is and how does it impact. I will try and answer some of the basic questions through this post.
What is Algorithmic trading
Algorithmic Trading is electronic trading where we implement various strategies or algorithms with the help of various advance mathematical models for taking transaction in financial market in a much faster way with low risk.
Here we use computer programs for executing orders following a selected algorithm or strategy and the order gets executed depending on different aspects such as timing, price or quantity of the orders and some times with out any human intervention.
What is an algorithm
Algorithms are actually a set of steps to perform a particular job or to solve a particular problem. Even if in our daily life we use algorithms to do everything. Similarly, in programming languages we at first implement algorithms depending upon what kind of job we need to do and implement the strategy by which we can perform the job step by step in a chronological order and instruct the computer through programming languages.
Let’s take a real life example:
When we need to go to a known place we at first decide in our mind how to reach the place spending less time so for this our memory implements an algorithm asking for how to reach the place by using a particular way and the particular road which road. Then we start from our place and easily reach the place.
Similarly in programming language to do different kind of job we implement different algorithms and depending upon that, we code a program in through various programming languages platform and through that we instruct the computer to do the particular job.
What type of strategies can be used through algorithm?
In financial markets, some popular strategies followed by the algorithmic traders are
Trend following- This is an investment strategy that tries to take advantage of long term moves that seem to play out in various markets.
Delta neutral strategies- In financial markets, delta neutral describes a portfolio of related financial securities, in which the portfolio value remains unchanged due to small changes in the value of the underlying security. Such a portfolio typically contains options and their corresponding underlying securities such that positive and negative delta components offset, resulting in the portfolio’s value being relatively insensitive to changes in the value of the underlying security.
Arbitrage – In economics and finance, arbitrage is the practice of taking advantage of a price difference between two or more markets.
Scalping- It is a method of arbitrage of small price gaps created by the bid ask spread.
Mean reversion- This is a mathematical methodology used in stock investment and other processes also. Here we calculate the average price of a stock and when the market price became less than the average price then the stock became attractive for buy and sell it on average price or above of it.
Transaction cost reduction – Here to reduce the transaction cost of large orders using high frequency trading wherein we break the transaction into several smaller orders and send to the market over time. We can name this as “iceberging” as well.
What are the abilities required to become an algorithmic trader?
To be an algorithmic trader, one needs in depth knowledge of any programming language and also interest on mathematical methods. Along with this knowledge, some behavioral skills like innovative attitude, ability to learn fast also with that interest on research jobs , risk taking ability , ability to take challenges etc. are also required to became successful in this profession
What is the scope of algorithmic trading in India
India has a competitive market for equities, futures and options, commodities, foreign exchange and currencies. But it was just two year ago that direct market access (DMA) to exchanges was allowed. Although official figures don’t exist, the consensus opinion is that about 5% of volume in equities is traded algorithmically and between 15% and 25% in future and options. Indian market is the third largest market only beaten by the US and CHINA and the growth rate is still very high so we can assume that, algorithmic trading is going to be lot more popular in Indian financial market.
Author: Bratin Mukherjee, Analyst, Kredent Group
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