The new generation is not ignorant of technology and its benefits. Whether connecting on social media for fun or learning the tricks of; algorithm trading for entering the markets, we talk straight-up business over here. Not monopoly money but actual hard- earned money.
Most of my acquaintances have learned Algo trading, and some apply it to its fullest. However, every time we are talking over a cup of chai, there’s always this one confused friend who does not know when the iron is hot enough to strike, especially in the dynamic and ever-evolving markets.
TIP: Algo trading automates the trading process in STOCK markets by swiftly and precisely implementing orders based on a set of well-defined rules. They eliminate human error (provided the algorithms were developed without them) and remove the risks of acting on emotion.
One could say what he feels is a sense of risk emerging from his lack of knowledge and proper guidance. But nothing is rocket science unless it’s the actual study of rocket science.
A person as interested as a writer on Algo trading can explain and give you the best strategies from their own experiences and A-one observational skills. After all, we learn better from other people’s mistakes than our own.
To help gain a much better understanding of quantitative trading, I want to give you an overview of all the different algorithmic trading strategies. Besides improving your knowledge, this should also help you decide what kind of algorithmic trading strategy you want to learn more about. Regardless of your risk tolerance, preferred time frame, and favorite asset class, there is a proper strategy for you.
1. Mean Aversion Strategies
In trading, the mean reversion strategy states that stock prices and financial indicators like interest rates and returns will have a tendency to return to the old mean rates.
For example, many investors purchased Infosys shares when the price crashed after the resignation of CEO Mr. Vishal Sikka (2017) because they expected Infosys stock to trade higher in the future when the management issues were solved.
Shares fall not because the CEO resigns but circumstances under which he quit (especially leaves suddenly unplanned). It creates uncertainty, especially when it’s planned and no planned succession. Uncertainty because of the resignation is the factor that drives share prices down!
The mean reversion tricks can be applied to fundamental factors such as buying a stock with a low PE ratio and expecting your PE to rise to the old average PE or industry PE.
A regular investor commonly follows this approach to buy the stock for long-term investments. Similarly, these principles can be applied using technical indicators to create short-term mean reversion trading strategies.
2. Trend Following Strategy
Trend following strategy is a rule-based trading mechanism that taps on the movements of long-term market trends instead of relying on any forecast or external information to decide when to buy and when selling a stock is the right thing to do.
It operates simply in contrast to complicated prediction methods that typically try to predict a future trend by analyzing the historical data and other factors.
Trend Following makes no prediction, and it is well known for its simplicity.
It is based on the idea that markets move for long durations of time in a given direction, leaving their footprints behind, and one can quantitatively identify such a trend and ride it safely.
Trend Following is also referred to as Time-Series momentum as we are mainly looking at data about prices at a particular period. (Years to be specific, e.g., 2018- 2019-2020-2021.)
In simple words, if prices show a trend in one direction, you trade in that direction until that trend stops or breaks down.
3. Sentimental Trading Strategy
A Sentiment trading strategy uses different indicators and ratios. These sentiment indicators attempt to estimate the investor activity for any signs of bullishness or bearishness before bull or bear takes hold of the market.
Many confuse Trend following and Sentimental strategies; the critical difference lies in the reference point used to identify a trend versus a sentiment, wherein we use the Performance of stocks compared to other stocks in a given space. In contrast, in Trend Following, we compare the current price of a stock/Index with its historical cost.
The sentiment trading indicators give you the positive or negative indication of particular security before affecting its prices. These indicators help us pack the front seats in the market before that ‘sentiment’ is reflected in the market prices.
Sentiment trading indicators can be qualitative, like opinion polls. Many companies provide these services of surveying market professionals and investors to conduct periodic polls and publish them.
If the above seems too technical for some of our readers, here’s a simple breakdown- Price moves in waves, and you are trying to catch one of these three stages:
– Momentum switch: your algo is trying to catch the start of a new wave.
– Countertrend: the algo is trying to anticipate the peak or bottom of an existing wave. – Zero cross: The algo is entering the mid-point of a current wave and assumes there is room left before reaching a turning point.
Each market is a different jungle, and one of those three stages could be its weakness.