In the financial markets, stock market traders typically need manual intervention to place orders, as full automation is not a common industry practice. This limits their trading capacity as they will have to spend screen time observing the markets, finding the trade, and executing the orders (put buy, sell, or stop loss orders). Also, their trade execution speed is limited. However, there is a solution to these limitations - algo trading.
Algo trading refers to the use of automated systems that can execute trades on behalf of traders, eliminating the need for manual intervention. These algorithms can execute trades based on pre-defined strategies embedded in them. With algo trading, traders can take the trades without the limitations imposed by manual order placement.
What is Algorithmic Trading?
In the world of financial markets, the use of algorithms to generate buy or sell signals has become increasingly popular. These algorithms, also known as trading strategies, are created by users and are designed to analyze market data and make trading decisions based on predefined rules.
How does algorithmic trading work?
Suppose a trader is using an algo trading strategy which is programmed as per the below criteria:
- Monitor the stock price in real time.
- Identify the highest price reached over a specified lookback period (e.g., the highest price in the last 10 trading days).
- Place a buy order when the current price surpasses this recent high.
- Monitor the lowest price reached over the same lookback period.
- Place a sell order when the current price falls below this recent low.
The system would execute these buy and sell orders automatically based on the defined criteria, without the need for manual intervention from the trader.
Six Major Components of Algo Trading
Algorithm Development
Creating mathematical models and rules that guide the decision-making process in trading
Data Analysis
Market data analysis is crucial for understanding trends, identifying patterns, and making informed investment decisions
Automated Trade Execution
Automated execution allows for efficient and timely execution of trades based on predefined rules
Risk Management
Essential for minimizing potential losses and protecting investment capital from market volatility
Backtesting
Testing trading strategies for validation and efficacy using historical market data
Strategy Optimization
Continuous refinement of strategies based on prevailing market dynamics and performance analysis
How Algo Trading Platforms Empower Retail Traders and HNIs?
Algo trading platforms provide retail traders and HNIs with advanced tools for automated trading that utilise algorithms and market data analysis with automated high speed execution for profitable trading.
#1 Algo eliminates the advantage gap institutions have compared to retail investors
In the past, retail traders were often at a disadvantage compared to larger players in the market, such as institutional investors and hedge funds. However, with the widespread availability of algorithmic trading platforms, retail traders and HNIs now have the tools and resources to compete on a more level playing field. These platforms allow for the automation of trading strategies, allowing traders to execute trades at lightning-fast speeds to achieve higher returns on their investments.
#2 Traders can participate more actively in the trading markets while remaining passive
By utilizing pre-programmed instructions, traders can execute trades automatically based on a set of predefined criteria. This eliminates the need for constant monitoring and manual execution of trades. Algo trading can be particularly beneficial for traders who want to take advantage of market opportunities without being actively involved in the decision-making process.
#3 Reduction in Emotional Bias and Impulsive Decisions
Traders often lose big due to emotional overwhelming (extreme fear or extreme greed). These emotional biases drive irrational and many times impulsive trade decisions. However, Algo trading is based on qualitative analysis and data-driven trading decision-making. It eliminates emotional biases from trading and empowers traders to execute trades based on logical parameters rather than emotional compulsion.
#4 Benefit from Diversification and Risk Management
It is difficult for a trader to manually trade across multiple markets or trading segments. Automated algo trading platforms can allow traders to simultaneously take position in various trade segments and multiple stocks. These platforms allow users to spread investments across multiple markets while implementing risk management protocols such as stop-loss orders and position-sizing algorithms.
#5 Backtested strategies for favorable outcomes
Algo trading platforms offer robust backtesting capabilities, allowing traders to evaluate the performance of their strategies using historical data before actually risking the trading capital. Through backtesting, traders can identify and fine-tune strategies before deploying them in live markets, thereby increasing the likelihood of success.
Insight by Thrive Fintech
Is it Safe to Trade Using Algorithmic Trading Platform?
While every strategy carries inherent risks, properly tested algorithms can enhance efficiency and precision in execution. Today, majorly 70-80% trading volume in USA is done via algorithms (institution to retail level), even for routine buy-sell orders. Trading through a platform that has proper risk mitigation mechanisms and multi-layered risk management systems is critical for safe algo-based trading.
Evolution of Algorithmic Trading in India: From DMA to Retail Accessibility
In 2008, India saw a groundbreaking shift in trading with the introduction of Direct Market Access (DMA) by SEBI. By 2012, SEBI has implemented new measures to simplify the Direct Market Access (DMA) service allowing investors to directly connect to the stock exchange's trading system without a broker's involvement. This empowered institutions to trade via automated algorithms.
Algorithmic trading has since flourished, using advanced models across equities, options, and futures. This era also witnessed the rise of High-Frequency Trading (HFT).
Aided by advancements in the Internet and computational technologies, India has witnessed significant transformations post-2020, marked by a surge in algo trading volumes and an increased adoption of algorithmic (algo) trading among retail investors. The emergence of algo-trading as a faster, more efficient trading method has been further fuelled by SEBI's regulations that promote Algorithmic trading while ensuring market fairness.
Bottomline
Today, retail traders have easy access to algorithmic trading through industry-leading platforms like Thrive Fintech. For more details on how to start algo trading in Indian Markets, contact Thrive Fintech experts here or call us.
