What is Algo Trading? How does it work?

You know more than 70 % of the trade that happens in NSE in India is through Algo trading. It is the future of the share market and trading. The number of traders shifting to Algo Trading is increasing day by day. The development of Fintech companies also helping the market for the automation

Algo Trading has many advantages as compared to share trading by human beings or traditional trading. Among the retail traders, they are not interested in algorithm trading.

They wish to do all the processes to be done by themselves including the creation of a watch list, analysing of the trend and technical indicators etc.

These activities may need a lot of time and patience. The development of technology like AI (Artificial Intelligence) and Machine Learning can help us make the entire share-trading process automated.

What are Algorithm and Trading

Algorithms mean computer programme which help to analyse the selection of stock in the equity market or Futures and Options contracts. It can analyse the technical and the fundamentals of the underlying as defined in the strategy.

These algorithms in Algo Trading are commonly known as a Strategy. This strategy will be programmed in Algo Trading applications. The application or Algo website will take care of all the trading activities

How Algo Trading Works

We need some requirements to start an Algorithm Trading. The first one is a winning strategy with proper risk and money management. Then we need a Trade Engine to load the strategy. The last one is the Algo Enabled broker to execute the orders as per the direction of the trade engines. 

1. Strategy

For activating the Algo trading, It is an important stage in your entry to this space. Your strategy decides your profit, loss, entry-exit, risk and money management.

Strategy can be created with the help of technical analysis, fundamental analysis, Option Greeks etc.

If you are not good at creating an Algorithm Trading Strategy, cloud platforms like Tradetrone allow you to subscribe to a winning strategy from Strategy creators. In this case, you need to pay a fixed fee or a percentage of profit or both as a fee for the subscribed strategy.

Tradetron will show you the Strategy states of all the strategies listed in their marketplace. You can select a filter and select one based on profitability, capital employed etc. 

Suppose the strategy may be to buy a particular stock in Nifty 50 when it reaches above the 50-day Exponential Moving Average and RSI 60. We need to execute it at the Market Price. Sell it when the price of the stock reaches more than 10% or at a Stop Loss of 5%.

Here you define the 

1. Market ( Cash Market), 
2. Strategy Signal – Buy when the stock price reaches above 50 EMA and RSI 60
3. Price Execution – Market price
4. Exit – Sell it when the price of the stock reaches more than 10% or at a Stop Loss of 5%.

Manually to place these orders, we need to be alert or at least set an alert in charting or broker sites. Algo Trading will automatically take the orders even when you sleep.

Just shifting to an auto trading system will not make you a profitable trader. The important thing is the best strategy as per your risk appetite.

2. Trading Engine

You can define the strategy in the Trading Engine. The trading engine will take care of the trades. It constantly checks the strategy and whenvere the entry, modification and exit come true, it will act accordingly.

Here the trade engine will check the strategy conditions with the help of instant data from the market. When it finds the match of the condition, it sends buying, selling or modification signal to the broker  

Backtesting your strategy is also a crucial part before deploying it. Before going for live automation of the strategy, do a paper-trading for at least 15 days. Then you can understand the strength and weaknesses of the strategy. If you find it working good, then go for live deployment.

3. Broker

We need a broker to connect with the Trade engine. So brokers must be enabled for Algo Trading. It may be through Application Programming Interface (API) integration or direction integration with the broker application by using the user id and password.

Many brokers charge a fee for their trading API. But you can see the brokers giving it for free like Finvasia

Why do we need Algo Trading?

This automatic trading has some benefits as compared to the trades of human beings or traditional trades.

i. Emotion Free Trading

We know that Algo Trades is executing as per the defined strategy without any interference of human beings. So the main benefit of Algorithms Trading is Emotion Free trading. It takes positions without the fear of losing and it can not become greedy also. It acts as on how the strategy was formed and defined. It blindly follows the entry, exit or holds rules. So it is essential to create a strategy with proper money management.

When we do manual trading, there are many discretions and emotional factors that will affect us and it will become a villain in the success of a trader

ii. Fast Execution

Algo Trading is a fast method of trading. Algorithm software is executing the trades in a fraction of seconds at precise price points. It will not be possible by a human being even if he stays in front of the system during trading hours.

If you follow Algo Trading, you can get fast and precise trades as per your strategy.

iii. Many Trades at a Time

In Algo Trading, you can take many trades at a time by using the different strategies in the system. It is also difficult for a human being to take many trades at a single point in time. So it can be scalable

iii. Unlimited Market Watch

As a human trader, you can watch a limited number of stocks and segments before making a decision. Your scanning speed is limited as compared to Algo Trading. It can scan unlimited stocks or instruments and can make a decision based on it 

Conclusion

Please don’t hesitate to shift to Algo Trading as it is the future of trading. What we find from the retail traders is that they are still reluctant to accept Robots in the trading space. Anyway, it may take a little more time to spread it in India for the fully automated trading system in all the traders’ homes.

We hope that the future of strategy creators is also bright. They can create a winning strategy, research and backtest it. Then it can be sold to traders. These traders can subscribe to it and deploy it in their broker terminal. If they earn a profit, a small portion can be shared. The rest will be managed by the Algos. It is highly suitable for part-time traders with a full-time job