May 1, 2019

What is algo trading? A guide for beginners

May 1, 2019
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5 minutes

Algorithmic trading or automated trading is a trading method that uses a computer program following a set of instructions dictated by an algorithm to place trades. An algorithm is a set of directions machines (usually computers) follow in calculations or other problem-solving operations. For example, the most basic version of an algorithm would be an algebraic equation coupled with the rules of algebra, ensuring a consistently executed, correct answer every time it is run.


If we were to take:

A + 1 = B


A plus 1 is equal to B, so that no matter what value A is, B is greater than it by 1.


The successful execution of this equation is dependent on the system that answers it being given the rules of what + and = mean, ensuring a consistently correct answer every time.


Most traders who use algo trading use a system known as HFT (high-frequency trading), which means placing several trading orders across multiple markets based on multiple parameters to maximise profit opportunities.


Algorithmic trading is a more systematic approach to trading that relies more on data and calculations than trader intuition. It also takes emotions, which can undermine a well-thought-out trading plan, out of the equation.


In addition to mitigating the impact of human emotions on trading strategies, automated trading can respond to market variables and execute trading orders much more quickly than humanly possible, process lots of data much faster than humans, and monitor the market 24/7. This means traders don’t have to constantly be watching multiple charts and can sleep at night knowing their strategies are still working for them. Capitalise elaborates on the benefits algorithms have over humans here.


When used for trading purposes, algorithms can be used in 3 key ways: order execution, arbitrage, and trend trading strategies. Trend trading strategies use algorithms to monitor and/or respond to timing, price, quantity, and/or mathematical models such as those used for technical analysis. Some examples of technical indicators that can be incorporated into trading strategies include moving averages, MACD, RSI, Bollinger Bands, and Pivot Points.


Let’s say a trader wants to condition a trade on an asset pair’s moving average, for example. They come up with a strategy such as the following:



Where 100 is the number of bars being taken into consideration, Day is the bar period, and Close is the bar price used in calculating the moving average.


If the strategy is made into an algorithm, theoretically that means it can do a few crucial things: monitor the price of EUR/USD and the pair’s moving average values, recognize the instant the price of EUR/USD crosses the moving average given the parameters set, and execute the trade immediately once it does.


Doing all of this benefits the trader by: 1. Freeing them from having to monitor the price of EUR/USD and its moving average to wait for the conditions to be right to make the trade, 2. Recognizing the fulfilling conditions and making the trade much more quickly than humanly possible, which also means being able to buy the assets faster than a competitor, and 3. Removing the influence of emotion on the trade, ensuring that the trading strategy is carried out as it was meant to, with no deviations.


In addition to placing trades based on market conditions, algo trading can also control the execution of trade orders. For example, TWAP (time-weighted average price) strategies allow traders to buy or sell large quantities of assets in smaller quantities spread out evenly over a specified time period. This is advantageous because when large trade orders are executed all at once, it affects market perceptions and thus prices. TWAP strategies allow traders to execute large orders while keeping the price close to the true market price rather than inflating or deflating it in a way that would be detrimental to the trader’s portfolio.


Relatedly,VWAP (volume-weighted average price) strategies implemented by algorithms predict a stock’s volume pattern, either for a partial day or a full day, and then create a trading distribution based on the projected volume pattern. The goal of this execution strategies is the same as that of TWAP: limit the effect large trading orders have on market perceptions and prices.


Arbitrage is the action of simultaneously buying and selling assets on different markets to profit from temporarily differing prices for the same asset. There are three main difficulties of using arbitrage: the very short times for which opportunities exist, the challenge of buying and selling simultaneously (especially in the crypto market), and transaction costs eating into profits. Algo trading can account for some of these problems better than human traders, recognising and pouncing on opportunities instantly and thus being better able to buy and sell at the same time. However, it is worth bearing in mind that most brokers forbid arbitrage.


The idea of trying to create algo trading strategies may sound intimidating if you don’t know how to write algorithms or code. But as it turns out, this is not the only way.


Introducing Capitalise, the world’s first automated trading platform empowering traders to automate their trading strategies by simply typing them in plain English. With its natural language interface, intuitive design, and plenty of technical and fundamental indicators to choose from, Capitalise allows retail traders to maximise their trading strategies with automation. Traders simply type if-then strategies into the wizard and Capitalise monitors the market and executes their trades from start to finish. Users can trade forex, stocks, and crypto using the Capitalise platform and for a limited time, it’s free.


One example of a trading strategy that can be entered into the platform for execution is the following:


In this strategy, the terms in the parentheses after “moving average” describe the parameters being set. “50” is the number of bars the moving average takes into consideration, “Day” is the bar period, and “Close” is the bar price used to calculate the moving average.


Curious? Interested? Intrigued?


Check the Capitalise platform out for yourself and see how easy automated trading can be!

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