Algo Trading – Taking Emotions Out Of The Decision Making Process

We have all heard this at some point or the other that the way forward is the way that aligns itself with the changing trends. This holds true for every aspect in our lives and has been seen in the world of trading too.

Trading in stock markets has seen several changes over the years. From a time where paper certificates were issued to show your ownership in a given company, to moving towards making Demat accounts compulsory - the new way forward is guided by technology. Technology being more user-friendly these days, makes many activities for traders easy. Emerging technologies like AI and machine learning are being seen for their practical benefits. Though continued reliance of human touch is necessary, the expectations are heightened for these newer capabilities.

One such move is algorithmic trading. An algorithm is a set code that gives a computer or a machine some instructions that the machine then carries out. In other words, a computerized manner to carry out a process forms the base for an algorithm. Traders use various setups to come up with a profitable strategy in stock markets. Some prefer technical analysis, while others rely on fundamentals of a company. There are also the ones who believe in the newest addition to these schools of thought – quantitative analysis.

Using algorithms to carry out trades increases the pace of finding and executing a trade while reducing the possibility of clerical errors. It also eradicates any scope for human emotions ruling your head and making you place trades that are solely based on your attachment to a stock.

The reduction in time has led to three different kinds of trades being placed in markets – Low frequency trading (LFT), High Frequency Trading (HFT) and Ultra High Frequency Trading (UHFT). In LFT, trades are placed in a span of few minutes whereas HFT involves trading un a few seconds. UHFT is the fastest way of trading currently present where trades are placed and executed in microseconds!

In these kinds of trading, a strategy that one derives based on any of the abovementioned schools of thoughts is first coded in a computer language. The next step involves back testing the strategy on historical data and then applying it in live markets. More than often LFT strategies are written using the programing language Python while, as the placement time reduces, the language used is C or C++. HFT and UHFT require high end technology which is usually not possible for an individual investor to procure and use. Thus, only institutional investors place trades under HFT and UHFT currently.

India legalized algorithm trading in 2008. While the markets globally had been witnessing a crash, this acted as an optimistic news for Indian traders. Since then, the share of algorithm trading has grown multifold with the current market stake for these trades being more than 40%!

This stake is expected to rise further in the coming years, and we hope to see more access to for retail users to HFT and UHFT, something which is less used right now by the common man.

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