Though computerized order flow in the financial market began in 1970, it was introduced in India in the year 2009. Automated Trading System also refers to as Algo Trading or Algorithmic Trading. Traders’ task is only to provide instructions to the computer, after that, the computer will execute its task by itself. In India, The system’s popularity has been rising right now. World’s trading one-third percent comes from Algo Trading. Today you will get a brief overview of the specific subject along with its strategy and example.
What is the Automated Trading System or Algo Trading?
In order to understand Algo Trading, you need to understand the Algorithm first. An algorithm is a specific set of clearly defined instructions to be followed in calculations, especially by a computer. As manual speeds and frequency are much lower than a computer, traders use this system by providing a defined set of instructions or algorithms. Therefore, by using automated pre-programmed trading instructions, orders can be executed through Algo Trading. In India, the most commonly used Algo is Application Programming Interfaces (API).
Automated Trading or Algo Trading Strategies
There are a few common Algo Trading strategies. These are as follows:
- Trend-following Strategies
- Arbitrage Opportunities
- Index Fund Rebalancing
- Mathematical Model-Based Strategies
- Trading Range (Mean Reversion)
- Volume Weighted Average Price (VWAP)
- Time Weighted Average Price (TWAP)
- Percentage of Volume (POV)
- Implementation Shortfall
- Sideways Market Strategy
Now let’s come to the importance and limitation of Algo Trading.
Importance of Automated Trading System
- There is no risk of manual error and emotional up-downs in Automated Trading. In human trading, fear and greed control the trade to some extent but in online computerized trades, there is no such scope.
- A large number of orders can be placed within a short time span. For this reason, this Algo trading is widely used among HNIs (high net worth individuals).
- Time and speed are the two main factors of trading. Automated trading can trade in a short time frame with high speed in comparison to manual trade.
- Traders can save enough time as they don’t have to monitor the market so often.
Limitations of the Automated Trading System
- Algo Trading works worst in the sideways market. It only works properly in a clear-up and downtrend. For this reason, HNIs use the system more in comparison to retail traders.
- The instructions are quite difficult to learn, and it will take a lot of time.
- For applying the system, you need to have a very good computer system, a proper net connection, and other equipment.
- Primary users of this system are intraday traders.
Process of Setting up the Automated Trading System
Choose the Platform
The old way is (Nest Trader + Nest Pulse or Nest Trader + Amibroker + Nest Plus)
Besides this, there is Zerodha, they have introduced Streak for Algo trading without any coding knowledge. There you can get the opportunity to trade by using Automated or Algo Trading System. On the front page, you will get a video link. This video will guide you on Algo Trading. Besides this, general Algo features like Backtest, Baskets, Algo instruction samples, and basic guides are available there. We will go for a brief discussion regarding Backtest, Baskets, and VPS later.
From there, you can do Algo Trade.
Back Testing your Strategies
I have mentioned earlier that there are many strategies, that come under the Automated Trading System, such as Trend-following strategies, Sideways market strategies, etc. Now, the question is, how do you know these strategies will surely work out for your chosen securities? There are a few steps available by which you can be sure about your preference.
Backtesting on a Basket of Stocks
In order to play safe, you can apply these strategies on a bulk of securities, refers to as Basket. Therefore, a Basket is a collection of instruments. You can create multiple baskets, each basket contains 20 scripts. After adding your strategies on baskets, you can run a Backtest. This will help you to identify the top-performing Algos and also the top-performing stocks. You can run Algo only on well-performing stocks with well-performing strategies to get a must better result.
Going Live and Hosting the Algo on a Server
After a Proper backtest you can go live on the best strategy, Now, come to the main point. Suppose for some reason your server is down or your net connection is interrupted. What will you do then? Your entire hard work, time, the money will go in vain. This should not be done. There is a server, called VPS (Virtual Private Server). You have to hire this specific server which can run multiple operating systems.
One thing you should remember is that sometimes manual checking is important. Problems may arise at any time in anywhere exchange, brokers. For this reason, manual monitoring is important.
Video on Automated Trading System
A video is attached below, by which you can see a simple Algo trading in Nest Trader using a plugin called Nest Pulse.
Automated Trading FAQ
Automated trading is a mechanical trading system, termed algo trading. It is based on the algorithmic process which is a computer program that creates and executes orders automatically to the exchange or market. Traders just need to establish the trade rules for entry and exit points. The computer will accomplish the rest of the task automatically.
Nowadays. there is plenty of trading software available in the market. Among them, Metatrader 4 is best for overall algo trading. eOption for options trading, etc.
Algorithmic or algo trading is the system of applying computer programming to follow a pre-defined set of instructions for the execution of trades. Human traders may do many manual mistakes while placing orders but computer work technically without emotions. That’s how algo trading works.
However, this Algo trading certainly carries a positive overview. If you understand the system properly, you can certainly generate lumpsum profit. Before everything, you need to gather enough knowledge regarding the Algo Trading System and Instructions. The popularity of this system reaches its peak. Besides HNI, retail traders also start investing by using this Automated Trading System. You can find a discussion of SEBI (Securities and Exchange Board of India) on strengthening the regulatory framework for Algorithmic Trading and Co-location. You will find all of the significant information regarding Algorithmic Trading from this given link of SEBI here.