Over the past decade, the dynamics of financial markets has changed drastically due to the rapid development of information technology (IT). If you have seen the 2013 drama film ‘The Wolf of Wall Street’ starring Leonardo DiCaprio, you’d probably picture the stock exchange as a chaotic floor where everyone must yell their thoughts out loud in order to be heard. This was true until the 1980s. However, in the past two decades, there has been increased computerization of the stock market, which has led to automated trading.
Also known as algorithmic trading, automated trading is the use of a computer program to create orders and automatically submit them to an exchange or market center. The primary purpose of algorithmic trading is to minimize the undeclared costs of transaction in executing orders. With algorithmic trading, investors trading online can trade stocks automatically without the need for human intervention.
Not only does algorithmic trading make stock market trading convenient, but it also increases your chances of recording a profitable trade. Perhaps, this is the reason algorithmic trading systems dominate the financial markets today. Currently, algorithmic trading represents up to 70% of all U.S equity trading. Additionally, it is being increasingly used by hedge funds and investment banks in several countries. In these countries, algorithmic trading represents about 40% of the total turnover on the exchanges.
While the above statistics give an accurate account of algorithmic trading’s worth today, they do not tell the whole story. You still do not know how algorithmic trading drives the price of a stock, how it predicts the stock market, and how it increases your chances of profitability. However, that is about to change as I reveal all about the impact algorithmic trading has on financial markets.
Financial Markets Can No Longer Operate Without Algorithms and Automated Trading
This may sound like a bold statement but it is correct. Without algorithms, today’s financial markets would cease to exist. This is because algorithms have been deeply ingrained into our financial system. By eliminating human intervention, automated stock trading makes human emotion and impulse a non-factor in stock trading online. This eliminates the unpredictability in stock trading.
At the most basic level, automated trading allows buyers and sellers to find each other without the need of a broker. Generally, algorithmic trading is used for high-frequency trading (HFT). In this type of trading, high-frequency traders, also known as flash traders, place several trade orders across multiple markets and decision variables. The orders are executed quickly and based on preprogrammed instructions. The speed and massive scale at which the deals are executed allows the investors to expand their market reach and increase their chances of making a profit.
Other sophisticated algorithms analyze newsfeeds, stock performance, and earning statements to find attractive investments for the interested parties. This system is smarter, faster, and more efficient than any human trader ever. Following are some ways algorithmic or automated stock market trading can make it easier to trade the stock market.
1. Execution
Suppose you are a sovereign investment fund that has just placed an order on shares of Apple worth millions of dollars. Now, what chance do you think you have of finding a seller at the price you’ve chosen? More importantly, what do you think will happen to the share price before the order gets filled?
Not sure? This is where automated stock trading software can prove useful. It can break up the order and place it strategically over the course of the day. While you may not exactly profit from this strategy, you are likely to get a better price for your order.
2. Arbitrage
If you find a Louis Vuitton handbag priced at US$3500 in the UK and US$2500 in India, what would you do? Unless you have some other bright idea, you’d buy the bag in India and sell it in the UK. By earning the spread between the two countries, you win a profit at zero cost and without any risk. Similarly, algorithmic trading can alert you to take advantage of any price difference in futures and cash markets.
3. Trend Following
Today, you will find thousands of ‘investment experts’ who claim to have the best strategies for trading the financial markets profitably. While their strategies may or may not work, automated stock trading systems have proven to successfully grow wealth for investors. They do this by making use of indicators like momentum, averages, stochastics, etc. to trigger a buy-and-sell order.
The Future of Algorithmic Trading in Financial Markets
In the future, we will witness a high-level of automation of the financial markets that is nothing like what we have today. We will also see the algorithms used in trading become increasingly intelligent. The first glimpse of this is evident in algorithmic intelligence (A.I) trading software.
Now it’s important to understand that although it is marketed as such, most of the automated trading happening today isn’t really ‘intelligent’. Instead, it is just a set of elaborate instructions and action workflows lacking strategy. The main problem with ‘traditional’ automated trading is that is it is focused on short-term gains. As a result, it becomes difficult for investors to grow their wealth and retirement accounts.
Automated trading software that uses proprietary algorithmic intelligence (AI) solves this problem by analyzing, buying, selling or holding stocks to grow wealth for investor personal and retirement accounts. True algorithmic intelligence trading is automated trading that learns from the past, adapts to market conditions, and makes trade decisions accordingly. What is the result of this? Lower investment risk and increased chances of profitability. This would be music to the ears of many traders, which may include you.
