Algorithmic trading is a process in which orders are executed through automation and programmed trade instructions for variables such as price, timing, or volume. An algorithm is a series of instructions on how to solve a problem. Over time, computer algorithms send a small portion of their complete order to the market.
A wide variety of situations, e.g., managing orders, arbitrage, and trend trading strategies, can be exploited by algorithms.
Everything has advantages and disadvantages; similarly, algorithmic trading has significant pros and cons.
Advantages Of Algorithmic Trading
1. Increased speed:
The speed offered by algorithmic trading is one of its most important benefits. The algorithm can instantly analyse a broad set of parameters or indicators so that trading can be carried out without delay. The higher speed is vital since traders can capture price movements immediately after they take place.
2. Minimising human emotion:
The depreciation of human emotions is the most crucial benefit of algorithmic trading. There is no room for traders to become affected by their feelings because of the strategies already in place. When the required objectives have been achieved, a transaction is automatically carried out, and no trader has any opportunity to reconsider or question its implementation. Algorithmic trading controls both under and over-trading. The psychological aspects of this trade are absent, and there’s no room to deviate from the original strategy.
3. Ability to backtest:
Historical data is used to backtest the new algorithms that have been created. It will allow us to assess whether the strategy is working or not. The system may be adjusted and improved following the trader’s requirements based on the backtest results. The plan is viable, all rules are absolute, and there is no room for interpretation.
4. Improve Order Entry speed:
Algo’s trading system will automatically process transactions. The algorithm will respond to market changes and generate orders when the trade criteria have been fulfilled. The speed of entry and exit in the trading process is essential. Delays can lead to loss, even for a few seconds. Thus, traders will benefit from faster access and entry to capture price movements at their precise locations.
Algorithmic trading is based on algorithms and computers. It makes it quite simple to execute many transactions simultaneously and apply multiple strategies in parallel. It couldn’t possibly have been possible. The ability to monitor trading opportunities across several markets, assets, instruments, and orders can be accessed simultaneously. Without automation and algorithms, this leads to diversification, which is very difficult.
Disadvantages Of Algorithmic Trading
1. Dependency on technology:
The biggest flaw in algorithmic trading is its massive reliance on technology. In many cases, business orders are stored on a computer rather than on a server. This means the order will not be transmitted for execution when you lose your Internet connection. It’s not suitable for the entire algorithmic trading ideology. In such cases, traders are likely to lose money because they miss out on opportunities. In algo trading, systemic problems could result in massive flash crashes across the entire market.
2. Risk of overoptimization:
It is likely that, during live trading, the strategies prepared on paper will not yield a successful and efficient outcome. This is called overoptimism when, in live markets, the trading plan becomes unreliable. Although the strategies are based on historical data, they may fail if no proper methods are implemented!
3. Requirement of resources:
Algorithmic trading contributes to the reduction in transaction costs but also incurs a great deal of expenditure. High-quality resources, access to a server, and the development of algorithms via costly technology are needed for traders. The costs of data feeds, which contribute to developing intraday strategies, constitute a significant expense.
4. Loss of human control:
Algo’s commerce is entirely automated. For the people, there is no room to make their own decisions. The trader cannot be under any control to abandon the program and stop trading even if he knows that his strategy is not working in a particular scenario before executing an order. There is no way of preventing or controlling the loss, even if the program goes in a direction the trader does not wish for.
The fact that it’s subject to many regulations is another con of algo trading. Regions in various countries have reached No consensus on whether algorithmic trading should be legal. Algorithmic trading has a lot of restrictions that need to be addressed before any decision is taken on its launch.
As a bottom line, algorithmic trading is an efficient and effective trade method. The advantages of this approach are different from traditional trading methods. In particular, algorithmic trading helps reduce emotion’s effects on transactions. Emotions have a very negative impact on the trading process. A trader could be greedy for profits or scared of losses and make decisions he does not intend to make. For safe and secure trading, choose platforms like Share India.