Understanding what is robot trading: While trading in the stock market, you must have come across the term algo trading or automated trading.
In this article, we will understand what is robot trading (algorithmic trading), its benefits, and the various types of strategies that are used by algo traders.
What Is Robot Trading (Algorithmic Trading)?
Algo trading also known as Algorithmic trading, is a method of executing orders using automated pre-programmed trading instructions accounting for variables such as time, price, and volume.
Algorithmic trading(automated trading, black-box trading, or simply algo trading) is the process of using computers programmed to follow a defined set of instructions for placing a trade in order to generate profits at a speed and frequency that is impossible for a human trader
The defined sets of instructions are based on timing, price, quantity, or any mathematical model. Apart from profit opportunities for the trader, algo-trading renders markets more liquid and trading more systematic by ruling out the impact of human emotions on trading activities.
While you can build your own algorithm and deploy it to generate buy or sell signals, Manual intervention is needed for placing orders as full automation is not permitted for retail traders.
Benefits Of Algorithmic Trading
- Trades are executed at the best possible prices.
- Trade order placement is instant and accurate (there is a high chance of execution at the desired levels.
- Reduced transaction costs.
- Simultaneous automated checks on multiple market conditions.
- Reduced risk of manual errors when placing trades.
- Algo-trading can be backtested using available historical and real-time data to see if it is a viable trading strategy.
- Reduced the possibility of mistakes by human traders based on emotional and psychological factors.
Types Of Algorithmic Traders
- Mid- to long-term investors or buy-side firms—pension funds, mutual funds, insurance companies—use algo-trading to purchase stocks in large quantities when they do not want to influence stock prices with discrete, large-volume investments.
- Short-term traders and sell-side participants—market makers (such as brokerage houses), speculators, and arbitrageurs—benefit from automated trade execution; in addition, algo-trading aids in creating sufficient liquidity for sellers in the market.
- Systematic traders—trend followers, hedge funds, or pairs traders (a market-neutral trading strategy that matches a long position with a short position in a pair of highly correlated instruments such as two stocks, exchange-traded funds, or currencies)—find it much more efficient to program their trading rules and let the program trade automatically.
Algorithmic Trading Strategies
Any algorithmic trading strategy requires an identified profitable opportunity in terms of improved earnings or cost reduction. The following are common trading strategies used in algo-trading:
1. Trend-Following Strategies
The most common algorithmic trading strategies follow trends in moving averages, channel breakouts, price level movements, and related technical indicators.
These are the easiest and simplest strategies to implement through algorithmic trading because these strategies do not involve making any predictions or price forecasts.
Trades are initiated based on the occurrence of desirable trends, which are easy and straightforward to implement through algorithms without getting into the complexity of predictive analysis.
Using 50- and 200-day moving averages are a popular trend-following strategy.
2. Arbitrage Opportunities
Buying a dual-listed stock at a lower price in one market and simultaneously selling it at a higher price in another market offers the price differential as risk-free profit or arbitrage.
The same operation can be replicated for stocks vs. futures instruments as price differentials do exist from time to time.
Implementing an algorithm to identify such price differentials and placing the orders efficiently allows profitable opportunities.
3. Index Fund Rebalancing
Index funds have defined periods of rebalancing to bring their holdings to par with their respective benchmark indices.
This creates profitable opportunities for algorithmic traders, who capitalize on expected trades that offer 20 to 80 basis points profits depending on the number of stocks in the index fund just before index fund rebalancing.
Such trades are initiated via algorithmic trading systems for timely execution and the best prices.
Is robot good for trading?
Yes, Algo/Robot trading is good for the purpose of trading as it is automated and performs trades at a huge number of trades at once with high accuracy. Also, it helps you back-test your previous trades to find out where you went wrong. Also, as the trades can be conducted without supervision, they help you save time and transaction costs.
Algo trading is one of the best ways for an investor to ensure they do not commit physical or emotional errors while trading and miss out on potential profits.
However, algorithmic trading is highly technical and requires immense knowledge related to the financial market, data analysis, and computer programs.
Furthermore, algorithmic trading demands access to past asset performance, live market feed, and a detailed infrastructure of trading platforms and integrated networks.
That’s all for the article on what is robot trading, we hope you enjoyed reading it. Happy Investing!
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