What is algorithmic trading?

Any market investor’s typical trading day involves keeping a track of the market and placing buy and sell orders depending on the time, volumes and analysis. It has been going on for decades now. 

But, technology is changing the way we used to trade. It has given a better alternative to manual trading. Investors can simply write an algorithm that includes specific trade instructions and then the trade is automatically generated by the system.  

An algo trading is typically defined as execution of trades by feeding pre-defined instructions or programs to the computer. Algorithmic trading uses historical information and data to execute intelligent and better trades.

For instance, if a trader wants to buy 1,000 shares of an IT company when it touches Rs 500 and sell the shares when the stock hits Rs 550, he can simply feed these instructions by writing a computer algorithm.

As soon as the stock price hits Rs 550, the trade will be automatically executed. In this case, it is not required for the trader to track the stock price all day long and execute trades manually. Here, the trader used stock price as a metric, while there could be numerous other instructions like moving averages, volumes etc.,

Algo trading makes it easier for traders to reduce human errors and execute time-saving trades. It also takes complex human emotions -- which can hamper the effectiveness of the trade -- completely out of the equation.

Investors often miss critical trades as the price movement is very fast. In some instances, the stock movement is so volatile that it can change the entire nature of the trade. With the help of algo trading, trades are timed correctly to avoid significant price fluctuations.

Algo-trading can execute trades which are almost impossible for humans. The rise of algorithmic trading has led to a significant drop in transaction costs. Some trading strategies can also be back-tested using real-time and historical data to see if they are viable options.

Institutional investors like mutual funds use algo trading to make massive purchases of stocks. As it gained popularity, most retail traders have also joined the bandwagon and started employing algo trading. Besides increasing chances of making higher profits, algo trading ensures more liquidity in markets.

While globally, 70-80 percent of market volumes come from algo trading. In India the figure is somewhere between 40-50 per cent. As volumes rise, there are some concerns that brokers are luring investors by claiming these cutting-edge technologies would generate higher returns. Markets regulator Sebi recently asked algo trading services to not mention any reference to past or future returns.