Here’s an attempt to describe the Algo Trading business in layman’s terms. Let’s split the phrase into words – ‘Algo’ and ‘Trading’. As you may already know, the word ‘Trading’ here stands for the action of buying and selling stocks in the capital markets. The another word ‘Algo’ here stands for the term ‘Algorithmic’. If you already know what an algorithm is, you can skip the next paragraph.
An algorithm is a clearly defined step-by-step set of operations to be performed. Let’s say if you are assigned a task to drink water from a bottle, the algorithm or set of operations for that will be – to get the water bottle, open the cap, drink the water, close the cap and place the bottle at the right place. Simple. Similarly in a computer system, when you need a machine to do something for you, you explain it the job clearly by setting instructions for it to execute. And that process is also called ‘programming a computer’.
Now, many of you might already know that before the electronic trading took over, the stock trading was mainly a paper-based activity. There were actual stock certificates and one needed to be physically present there to buy or sell stocks. You can read what was it like to trade before electronic trading took over. And then there was dematerialization (DEMAT). Actual certificates were slowly being replaced by their electronic form as they could be registered or transferred electronically. It increased the fluctuations in the stock-prices because now the trading process was faster. But then with the technological developments came the next big thing – ALGO TRADING.
Now, you can write an algorithm and instruct a computer to buy or sell stocks for you when the defined conditions are met. These programmed computers can trade at a speed and frequency that is impossible for a human trader. This process can be semi-automated or completely automated and this is why the terms automated trading and algo trading are used interchangeably. But there is a small difference between algo trading and automated trading.
If you are an experienced stock trader with a trading strategy, you can best utilize the algo trading by setting instructions for a computer (write an algorithm) to trade when the defined conditions are met.
Knowledge of technical analysis of stocks/trades plays an important role in developing a profitable trading strategy. Technical analysis is academic study of chart patterns and trends of publicly traded stocks. Soon, I will provide content here to help you understand the technical analysis. Feel free to comment! Cheers!
Happy Trading!
