Algorithmic trading, also known as automated trading, systematic trading, trading bots, or algo trading, allows operating in financial markets 100% automatically, without the need for any trader intervention. Basically, it consists of programming a strategy that tries to take advantage of inefficiencies that arise in the market.
What is Algorithmic Trading?
Algorithmic trading requires the use of computer programs that seek patterns that have appeared in the past with the intention that they continue to occur in the future and be able to obtain returns in the market. To execute operations in financial markets, we must first “create” the idea of the algorithm and perform a backtest (test in the past) to check if it would have been possible to obtain a profit and subsequently analyze different scenarios to verify if they have possibilities of repeating in the future. To be able to do this, we need reliable market data, ensuring that there is no “bad tick” that could contaminate the study of the strategy.
Algorithmic trading systems can be used in various financial markets, including stocks, bonds, currencies, and commodities. If there is a chart, there is a system. But not just by having a system you can win. It is also necessary to analyze the impact of commissions, slippage (the latency with which the order is executed), the liquidity of the market in question, etc.
The positive impact on the psychology of the investor.
The main benefit is being able to operate massively in different assets with different strategies. To this we must add the positive impact it has on the psychology of the investor. Having the tranquility that the job well done is already done and that we do not have to rack our brains asking ourselves when to enter, when to exit, etc. Knowing that we have trading strategies that have already been tested and proven effective.
The simplest works better if well diversified
Perry Kaufman in his book “New Trading Systems and Methods” explained very simple strategies such as a simple moving average crossover, and if applied to many different assets, the average result was always encouraging. On the other hand, Oscar Cagigas in his book “Trading with Automatic Systems” emphasized the advantages of operating with active systems that have a long-term bullish bias, such as futures on indices.
Managing Greed and Fear
Emotions and biases often cloud a trader’s judgment and lead to irrational trading decisions, such as over-leveraging, adding to winners, martingales, opening and closing positions compulsively. Algorithmic trading eliminates these emotional factors, as long as the trader never intervenes with their ego, stopping strategies, constantly adding new ones, or rotating from one system to another.
The one who earns the most with automatic systems is the one who spends the least time looking at quotes on the screen. The best thing an algorithmic trader can do is put it on autopilot and check their account once a day at most. Spending more time has the opposite effect on returns because there is a risk of disagreeing with a trade and wanting to close it, contaminated by the news that bombard us every day. Remember that journalists always prepare why the stock market has risen today and why it has fallen and, at the moment of publishing, you only have to look at how the price quote is to publish one or the other. An algorithmic trader is not going to question the news. It doesn’t matter if the news is good or bad as long as there is news.