Algorithmic trading, automated trading, or algo trading is a type of trading using a computer program that follows a set of instructions (an algorithm).

The algorithm is defined by timing, price movements, quantity, market data, or any mathematical model. Besides providing huge profit opportunities for traders, algorithmic trading helps elevate market liquidity and offers more systematic trading by eliminating the influence of human emotions.

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How does Algorithmic trading work?

Algorithmic trading is very efficient because natural factors do not influence the trading process. You don’t have to be near your computer/phone at all times. The algorithm detects when the preset criteria are met automatically and makes the trade. You’ll not be involved in the mundane aspects of trading. Instead, you play a significant role in the critical, strategy-creation stage.

 

Quantitative trading vs algorithmic trading

Quantitative trading involves developing trading strategies using sophisticated mathematical models. It requires conducting research, analyzing historical data, and employing complex mathematical and statistical models to identify profitable trading opportunities.

Algorithmic trading is a type of quantitative trading that uses pre-programmed algorithms. The algorithm determines various critical aspects of the trade, such as the price, timing, and quantity. It executes the trade automatically, without human intervention.

 

What are the steps involved in Algorithm Trading?

  • Creating a strategy

Having a suitable strategy in place is the most important step in algorithmic trading. The strategy’s efficiency has a significant impact on the trade’s success. You can use common strategies like the mean reversal or arbitrage strategy or create a unique strategy tailored to your needs.

  • Setting up the algorithm

You convert your formulated strategy into an algorithm that must be automated and approved by authorities. Algorithmic trading is totally legal in every jurisdiction. Once approved, you can deploy your algorithm and trade.

  • Creating or purchasing trading software

Sophisticated trading software is essential to algorithmic trading. You can either create your software or purchase pre-built solutions such as TradeSanta.

Executing trades

The tricky part is over. You’ve developed the strategy, automated the algorithm, and set up the infrastructure. You only have to wait for and respond to trading signals generated by the algorithm.

Example

Assume a trader follows the classic dual moving average (DMA) trading strategy – a trend-following strategy:

  • When a coin’s 50-day moving average crosses above its 200-day moving average, buy 50 shares. (A moving average smooths out day-to-day price fluctuations and thus identifies trends by taking an average of previous data points.)
  • When the coin’s 50-day moving average falls below the 200-day moving average, it’s time to sell.

An algorithm will automatically monitor the price (and the moving average indicators) and place buy and sell orders when the trader’s conditions are met. As a trader, you don’t have to enter orders or monitor live prices and graphs manually. The algorithmic trading system correctly identifies and executes the trading opportunity.

 

Automated Trading Benefits

Here are some of the benefits of algorithmic trading:

  • Trading is quick and precise.
  • Automated trading offers lower transaction costs.
  • Algorithms check multiple market exchanges at the same time.
  • When placing trades, there’s a lower chance of making a mistake.
  • Trades are timed correctly and instantly to avoid significant price changes.

Algorithmic trading allows stock trading, crypto, and other financial instruments using abstract algorithms, statistical equations, and human supervision. Algorithmic traders often use high-frequency trading technology, allowing them to execute thousands of transactions per second.

 

What to Look for in Automated Trading Software

There are a few characteristics that most of the best automated trading platforms should have. As you make your selection, keep these features in mind.

  • Access to financial markets

You won’t be able to access every stock market and crypto exchange with automated software. TradeSanta, for example, is only available for trading cryptocurrencies. Check that your preferred algorithmic trading software has access to your choice of financial markets and exchanges.

  • Intuitive UI

Although computer programs do most of the job, you’ll still have to manage and tweak your automated trading platform. Choose software with a user-friendly interface that allows you to make quick changes.

  • Historical data for backtesting

Backtesting relies heavily on charts and other historical data. Make sure your trading software offers detailed backtesting that spans multiple timeframes.

 

Automated Trading Systems

An automated trading system (ATS) is a variant of algorithmic trading that creates trade orders using a computer program and submits them to an exchange or market center automatically.

 

Algorithmic Trading Bots for Cryptocurrency

Crypto trading bots are software programs that generate and execute buy and sell orders to exchanges under predefined trading conditions. For example, a very simple trading bot could be configured to sell BTC when its price reaches a predefined level.

These trading bots help traders make decisions based on data and patterns rather than gut feelings. Trading with bots often increases the trader’s earnings, reduces their risks, and limits their losses across exchanges. Bots can help you generate passive revenue while you’re eating, biking, or doing anything else; you could be earning money through automated trades.

 

Why use crypto bots

The cryptocurrency market is highly volatile, and there are no closing hours. This volatility increases the chances of making huge profits on bitcoin and other cryptocurrencies. However, it also increases the likelihood of suffering significant losses.

A crypto trading bot can help mitigate several of these risks. Unlike humans, bots can make decisions solely based on available evidence and patterns, abstaining from desires and instincts. Furthermore, bots can run 24 hours a day, allowing you to trade while sleeping or busy.

Trading bots also work faster and more effectively than a human trader. They can analyze data and execute transactions on a variety of exchanges and cryptocurrencies when appropriately configured.

However, you must understand that a trading bot is not a definitive solution. You can boost your earnings with the right bot, but there are some disadvantages and risks to consider before using one.

  • Regular Monitoring

You cannot simply launch a bot and walk away; you must constantly monitor its performance and make necessary adjustments. Additionally, a bot may not consider external market factors, such as global events or breaking news, Elon’s tweets, and so may make poor trades in the absence of human intervention.

  • Competence

While some bots come pre-programmed with conventional trading strategies, most of them perform better when customized to the user’s specifications. As a result, you must have a basic understanding of both the market and technological aspects of trading with a bot.

  • Security

Crypto trading bots communicate with exchanges via Application Programming Interfaces (APIs), enabling two programs to interact without human intervention. Most bots and exchanges are centralized, so they are vulnerable to hacking. You must take precautions like protecting your API key and disabling automatic withdrawals. Additionally, you can conduct a background check on any bot you are considering.

 

Algorithmic Trading Strategies 

Any algorithmic trading strategy necessitates identifying a profitable opportunity in terms of increased earnings or cost reduction. These are some of the most common algorithmic trading strategies:

  • Trend-following Strategies
  • Arbitrage Strategies
  • Trading Range (Mean Reversion)
  • Volume-weighted average price (VWAP)
  • TWAP (Time Weighted Average Price)
  • Percentage of volume (POV)
  • Implementation Shortfall

 

Automated trading tips

  • Start with familiar concepts

Consider what you already know. If you have been investing in stocks for years, start with equity trading strategies instead of venturing into futures.

  • Always Understand Why

When creating an algorithmic investing idea, it is crucial to understand how it works. For instance, humans tend to overreact to significant changes in information and underreact to minor changes. Understanding human nature enables you to develop a trading strategy that takes advantage of this behavioral characteristic.

 

Is algorithmic trading the future?

The chances of success as an independent retail trader are dwindling by the minute. As is the case in many other industries, businesses that embrace technology outperform those that don’t. Traders who apply innovative new technologies significantly improve their chances of success. However, while the path to profits is simplified, the learning curve is steep.

Algorithmic trading can enhance the performance of a retail investor because:

Data science enables more effective strategy formulation and testing.
Algorithmic Execution improves trade and helps traders avoid behavioral errors.

 

Is algorithmic trading legal?

While algorithmic trading is legal, some people object to the way automated trading can affect markets. While their concerns may be justified, there are currently no rules or laws prohibiting retail traders from using trading algorithms.

 

How to start algorithmic trading

We recommend that you start by evaluating whether algorithmic trading is suitable for you. Use our cloud-based services. TradeSanta provides excellent tutorials for beginners. If you enjoy the process, you’ll eventually need to improve your data science knowledge and build your research to develop more advanced strategies.

 

Conclusion

Algorithmic trading is often used by crypto traders to gain a competitive edge over other traders in terms of speed, price, and volume. In the traditional stock market, algorithmic trading has evolved into high-frequency trading that is more focused on speed.

Trend following, arbitrage, and trading range (mean reversion) are the most conventional algorithmic trading strategies in cryptocurrency. However, you can start with cryptocurrency bots to leverage your level of experience with various exchanges, technical analysis, and trading in general.