Algorithmic Trading - Explained
What is Algorithmic Trading?
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Table of ContentsWhat is Algorithmic Trading?When did Algorithmic Trading Begin?Do it Yourself Algorithmic TradingKey Takeaways Advantages and Disadvantages of Algorithmic TradingAcademic Research on Algorithmic Trading
What is Algorithmic Trading?
Algorithmic trading is a system of trading whereby advanced mathematical tools and computer programs are used in facilitating trade and making decisions in the financial markets. Algorithmic trading is a method that helps in facilitating trade and solve trading problems using advanced mathematical tools. This system of trading uses automated trading instructions, predetermined mathematical models and human oversight to execute a trade in the financial market. In algorithmic trading, traders leverage powerful computers that have the capability to process complex mathematical formulas. The use of high-frequency trading techniques also helps traders to make multiple trades within seconds.
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When did Algorithmic Trading Begin?
Algorithmic trading was introduced in the 1970s, this was then highly computerized trading systems emerged in the American financial markets. The New York Stock Exchange also introduced a system in 1976 which enhanced the acceptance of electronic trader by traders. Algorithmic trading was popularized by Michael Lewis, an author who drew the attention of market traders and the public to high-frequency algorithmic trading. The combination of an algebraic equation and rules of algebra is an example of an algorithm. When algorithms are used as a system of trading, complex formals and mathematical models are combined to be trading decisions in the financial market. Algorithmic trading can be applied in different market situations such as order execution and arbitrage.
Do it Yourself Algorithmic Trading
When algorithmic trading was introduced in America, companies defined the structure of electronic trading, in the sense that average investors do not have access to electronic trading or do not know how to go about the system. Michael Lewis, an author who polarized algorithmic trading to the public also argued that companies who use the algorithmic trading system gained an advantage over other traders and engage in trading that only benefitted them and are detrimental to average investors. In recent times, Do-it-yourself algorithmic trading has become popular, this enables average investors to facilitate the execution of trades in the financial markets using high-frequency computers. The innovation of high-speed computers and the high speed on the internet has made this type of algorithmic trading even more popular and widely accessible by average investors.
Below are the key points to know about algorithmic trading;
- Algorithmic trading is a system of trading that uses high-frequency computerized trading systems to execute a trade in the financial market.
- With the help of high-frequency computers, investors are able to solve complex mathematical problems that facilitate their decision making in the financial market.
- Algorithmic trading first emerged in the 1970s, it was popularized by an author, Michael Lewis. This system of trading became widely acceptable in the 1980s.
- When it first emerged, the algorithmic trading system was used by institutional investors and companies, but more recently, Do-it-yourself algorithmic trading has become popular
Advantages and Disadvantages of Algorithmic Trading
The advantages of algorithmic trading are;
- Algorithmic trading reduces the costs associated with trading.
- This system of trading facilitates faster execution time in the trade.
- It offers varieties of benefits to institutional investors and large companies who have large trading volume because it aids an easier and faster execution of large orders.
- Market makers can create market liquidity using algorithmic.
Disadvantages of algorithmic trading;
- The speed at which orders are executed can create a problem in the financial market, especially if there is an absence of human oversight.
- Algorithmic trading has the tendencies of causing flash crashes in the market.
- It can cause a sudden disappearance or instant loss of liquidity which was created through rapid buying and selling orders.