Put simply, algorithmic trading systems are computer programs that are used to predict the financial markets to help traders. These systems use mathematical calculations to work out when trading conditions are favourable and then trade on behalf of traders. They follow the markets and monitor trends based on a number of variables, including timing, price, and quantity. They allow financial institutions to trade much more than they would otherwise be able to do. Humans are unable to act on these trends as quick as algorithmic trading systems, and they can also carry on while their users are doing other things.
There are a wide array of algorithmic trading systems, each programmed to suit particular trading markets. They can, amongst other things, be used for the currency markets, hedge funds, mutual funds and pension funds.
More often than not algorithmic trading systems, also known as automated trading technology, are used for short term trades. They will buy and sell within a short period, therefore taking advantage of small opportunities. Due to this, huge profits with one trade are rare as there isn’t the time for such dramatic changes. The reason for this is that most systems are designed to sell before conditions are likely to change in a negative way, whereas long term trades tend to have more ups and downs before reaping the rewards.
There are many advantages to algorithmic trading systems. As they are run by computers they eliminate human error, although humans are sometimes likely to take risks seeing the potential in the future, which won’t happen with algorithmic trading systems. The risk of a major mistake is significantly reduced as they are risk adverse. Although they can’t be 100% accurate, they are considered less risky than manual trading. As these systems are able to operate 24/7 and decisions can be made immediately (within seconds) they boost efficiency. As you don’t need to be a trading expert to be able to use them, it has allowed many more people to take advantage of trading.
Some form of computerised trading system has been around since the 1930’s. They have continually developed ever since, but their popularity has really exploded in the last decade. As they have become more advanced, their accuracy has also increased so mistakes are less common. Investors now feel that they can really trust algorithmic trading systems. Around 40% of trades are made using some type of algorithmic trading technology and this is likely to increase. Many predict that within a few years they will dominate certain trading industries. They are unlikely to completely replace humans but there is no doubt that they are here to stay. As long as they keep improving they will continue to grow in popularity.
Andrew Marshall (c)
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