Algorithmic trading is a trading method that has spread in recent years and that some brokers already adopt.
In this guide we will see what algorithmic trading is, how it works, where to do it and what is its regulation in Europe and in other parts of the world.
What is Algorithmic Trading?
Algorithmic trading is a way to trade stocks. Through computer software and with the use of particular algorithms it is possible to automatically open certain positions at specific market conditions.
This mode is part of automatic trading, in fact human intervention is drastically reduced.
Algorithmic trading emerged after the dematerialization of stock market orders in the 1980s. Especially today this negotiation method is widespread in the United States of America.
A computer can open a buying or selling position much faster than a human trader, for this reason many investors are taking an interest in this mode of trading, which in fact reduces what we can define human error based on emotionality.
When the speed of execution of orders is very high, it is called high-frequency trading (HFT).
How Algorithmic Trading Works
With algorithmic trading you can open positions automatically, but the human trader is the one who programs these algorithms.
Those who do not have the time, ability and temper to be in the markets all day may find it difficult to manage their open positions. In fact, it may lack a greedy entry into the market or it may exit a position too late.
Algorithmic trading: why do some traders use it?
Some traders exploit the potential of algorithmic trading for several reasons, some of which have already been mentioned previously. First of all, the time: not everyone has the possibility and the will to be in front of the monitor all day. In some cases it is also not recommended.
Other reasons can be the following:
- You can remove the emotionality due to human error.
- You can automatically set market entry following rare events.
- You can reduce your time in front of the monitor.
- You can better analyze your past performance.
- You can reduce risk by setting stop loss and take profit.
Clearly these are not rules, but opinions. Everyone should feel free to choose on his/her own. For example, the IG broker allows you to manually invest in the markets or use this trading mode, the choice is yours.
Algorithmic trading: what are the regulations?
Over the years, regulatory bodies have regulated this trading method with new obligations and requirements.
In Europe, MiFID 2 obliges those who carry out algorithmic trading and platforms to have suitable internal control systems, as well as particular information obligations to allow the authorities to monitor the phenomenon.
In the United States of America, algorithmic traders must register with the SEC (Securities and Exchange Commission), the US authority on financial markets and, in case, of request to provide details on their trading activity .
Algorithmic Trading strategies
The most popular algorithmic trading strategies are the following:
- Price action strategy, based on previously opened and closed trades, or on the maximum and minimum points on a candlestick chart;
- Technical analysis strategy, based on the use of technical indicators, such as the Bollinger bands, the stochastic oscillator, MACD, RSI and many others;
- Combined strategy, based on the use of price action and technical analysis simultaneously.
It is a trading method based on the use of automatic software, which, following algorithms and mathematical formulas, enter the market automatically.
Yes, the European MiFID 2 directive also deals with algorithmic trading, read the article to learn more.