Loding Loading ...
X
Century Financial Consultancy LLC ("Century") does not offer investment advisory or portfolio management services nor guarantees investment returns. We do not accept or make payments in cryptocurrency or digital currency. Our official website is www.century.ae. Beware of fraudulent companies or websites posing as Century. We are not responsible for any losses from using fake websites or entities. Trading in financial markets involves a significant risk of loss which can exceed deposits and may not be suitable for all investors. Before you start, please ensure you fully understand the risks involved.
  • AR AR
Century Financial Consultancy
  • Home
  • algorithmic trading

Guide to Algorithmic Trading Strategies

Algorithmic trading is the process of using a computer that follows instructions based upon mathematical formulae, to make automated trading decisions. Find out how to here.

Algorithmic trading is the process of using a computer program that follows instructions based on mathematical formulae, in order to make automated trading decisions.

By following the algorithm’s instructions, the computer makes the decisions for the trader as to whether to buy or sell various financial instruments, often by monitoring price charts. It will exit the position upon meeting the algorithm’s specified requirements.

Algorithmic trading is an effective way of minimizing risk when executing an order, as once the trader has chosen the model’s predefined principles, such as the exit price and position size, the computer makes the decisions based on this information. This lessens the likelihood of the trader making decisions based on emotion, rather than logic.

Automated trading software is predominantly used by hedge funds and investment banks, as algorithmic trading is most suitable for large orders, whether that be size or volume. Over 75% of share trades on U.S. stock exchanges originated from automated trading systems.

Algorithmic trading strategies

There are numerous algorithmic trading strategies which can be adopted by traders in order to save themselves both time and money.

High-frequency trading

This automated trading strategy involves placing a high volume of trades at a rapid speed in order to profit from small movements in price. Typically, the positions will be open for less than a minute or for just milliseconds. The aim of high-frequency trading is to make small profits, so there are often very high volumes of these trades occurring in one day. An algorithmic strategy for high-frequency trading is called scalping. In particular, scalping forex is common for trading currency pairs.

Arbitrage trading

Arbitrage strategies involve using an algorithm to monitor the market to find price differentials. This could be when two assets with identical cash flows aren’t trading at the same price, or when the same asset isn’t trading at the same price on all markets.

This could be useful if, for example, a stock is valued at one price on the New York Stock Exchange, but for less on the London Stock Exchange. This stock could be bought at the lower price on the NYSE, then sold on the LSE for a profit.

As these price differentials aren’t very common, it is useful to have an algorithm to locate them when they do occur. As these price differentials are often small, a large position is generally required to make a significant profit, such as in pairs trading.

Trend following

Automated trading systems can be used to monitor the market and various price charts, identifying patterns that identify the best time to execute a trade. The algorithm can base these patterns on trends that occur in both historical and current data, but trends can also be based on technical indicators, stochastic indicator, price movements, moving averages and mean reversion.

Mean reversion

This algorithmic strategy makes the assumption that even if the price of a stock deviates due to common factors such as breaking market news, over time it will move back to the average price. The trading range of a particular asset needs to be identified, then the computer can detect the average price using analytics. Typically, the average asset price is calculated using historical data.

VWAP trading

The VWAP, volume-weighted average price, is a benchmark that traders can use to execute an order as close to the average intraday price as possible. This intraday calculation looks to calculate an asset’s typical price by multiplying it with volume for a selected period (e.g. 1 minute). You then keep a running total of cumulative TPV and cumulative volume, just adding volumes for each 1-minute period, or for whichever period the trader has selected, and then divide cumulative TPV by cumulative volume.

These algorithmic trading statistics will not be useful for determining trends as they are purely a historical average for that day. They can, however, be used to gauge whether or not a trader has overpaid for an asset earlier than its trading day.

TWAP trading

The TWAP trading strategy (time-weighted average price) aims to execute the order as close to the average price of the security as possible, over a specific time period. This is often over the course of one day, and a large order will be split into multiple small trades of equal volume across the trading day. The purpose of this algorithmic trading strategy is to minimise the market impact by executing a smaller volume of orders, as opposed to one large trade which could impact the price.

Forex algorithmic trading

When trading the forex market, the efficiency of algorithmic trading online means fewer hours spent monitoring the markets, as well as lower costs to carry out the trades. Algorithmic trading can also be useful when hedging trades, in particular, spot contracts, where foreign currencies are bought or sold for instant delivery.

Triangular arbitrage is one common forex algorithmic trading strategy. It involves trading different currencies in the forex market with exchange rate discrepancies for an overall profit. This popular forex strategy involves three stages:Triangular arbitrage is one common forex algorithmic trading strategy. It involves trading different currencies in the forex market with exchange rate discrepancies for an overall profit. This popular forex strategy involves three stages:

  • Firstly, exchanging the initial currency (a) for a second (b)
  • Then exchanging the second currency (b) for the third (c)
  • And finally, exchanging the third currency (c) for the first (a)

The automated strategy is conducted exclusively via a computer, partially due to the rare occurrence of these opportunities, but also due to the speed at which the trades need to be carried out. A large amount of capital would typically be traded due to the fractional differences between currency prices.

Benefits of algorithmic trading

  • It avoids the likelihood of human error, caused by factors like emotion or fatigue.
  • Backtesting can be implemented to test a trader’s algorithmic strategy against historical data, in order to improve its accuracy, overall helping to minimise the potential risk.
  • Trades are executed more effectively as the computer follows instructions for the optimal buying or selling conditions, as well as timing trades to avoid price changes or slippage.
  • It is more efficient, as computers can action trades over fractions of a second, which is something that humans simply cannot do. This means that less time is spent monitoring financial markets.
  • Algorithmic trading can limit or reduce transaction costs, due to the lack of human intervention.
  • Complex mathematical calculations that would be too difficult for traders to perform themselves are done within seconds on a computer.
  • It allows traders to use multiple strategies at one time, as well as having a consistent trading plan.

Drawbacks of an algorithmic trading system

  • There is a risk that any fault with the algorithm or internet connectivity problems could lead to orders not being placed, duplicate orders being actioned, or even erroneous positions being taken.
  • It is difficult to constantly monitor the trading system as it can prove too fast-paced for human intervention, should a fault or issue occur.
  • It can lead to spikes in volatility, as these algorithms react to market conditions, potentially widening bid-ask spreads or not placing certain trades, which could ultimately harm liquidity.
  • High-frequency trading can amplify systemic risk by transmitting shocks across markets when combined with other factors. There is an argument that high-frequency algorithmic trading played a part in the Flash Crash in 2010, where the Dow Jones Industrial Average plummeted more than 1,000 points in 10 minutes.
  • Faulty algorithms can cause ripple effects across other markets, resulting in amplified losses.
  • How to learn algorithmic trading
  • Algorithmic trading can be a complex process and is mainly used by traders with a higher level of experience and knowledge.

Overall, algorithmic trading is a useful tool for professional traders to increase the volume of trades that they can make, while mitigating the risk of human emotion or error that negatively affects trades. It should, however, not be used as a substitute for careful manual trading, nor should any associated risks be underestimated.

Source: CMC Markets UK

Disclaimer: Century Financial Consultancy LLC (“CFC”) is Limited Liability Company incorporated under the Laws of UAE and is duly licensed and regulated by the Emirates Securities and Commodities Authority of UAE (SCA). This document is a marketing material and is for informational purposes only and must not be construed to be an advice to invest or otherwise in any investment or financial product. CFC does not guarantee as to adequacy, accuracy, completeness or reliability of any information or data contained herein and under no circumstances whatsoever none of such information or data be construed as an advice or trading strategy or recommendation to deal (Buy/Sell) in any investment or financial product. CFC is not responsible or liable for any result, gain or loss, based on this information, in whole or in part.

PLEASE READ THE FOLLOWING TERMS AND CONDITIONS OF ACCESS FOR THE PUBLICATION BEFORE THE USE THEREOF.

By use of the publication and continuing to access the publication, you accept these terms and conditions and undertake to be bound by the acceptance. CFC reserves the right to amend, remove, or add to the publication and Disclaimer at any time without any prior notice to you. Such modifications shall be effective immediately. Accordingly, please continue to review this Disclaimer whenever accessing, or using the publication. Your access of, and use of the publication, after modifications to the Disclaimer will constitute your acceptance of the terms and conditions of use of the publication, as modified. If, at any time, you do not wish to accept the content of this Disclaimer, you may not access, or use the publication. Any terms and conditions proposed by you which are in addition to or which conflict with this Disclaimer are expressly rejected by CFC and shall be of no force or effect.

No information as given herein by CFC in this publication should be construed as an offer, recommendation or solicitation to purchase or dispose of any securities/financial instruments/products or to enter in any transaction or adopt any hedging, trading or investment strategy. Neither this publication nor anything contained herein shall form the basis of any contract or commitment whatsoever. Distribution of this publication does not oblige CFC to enter into any transaction.

The content of this publication should not be considered legal, regulatory, credit, tax or accounting advice. Anyone proposing to rely on or use the information contained in the publication should independently verify and check the accuracy, completeness, reliability and suitability of the information and should obtain independent and specific advice from appropriate professionals or experts regarding information contained in this publication. CFC cannot be held responsible for the impact of any transactional costs or any taxes as may be applicable on transactions.

Information contained herein is based on various sources, including but not limited to public information, annual reports and statistical data that CFC considers reliable. However, CFC makes no representation or warranty as to the accuracy or completeness of any report or statistical data made in or in connection with this publication and accepts no responsibility whatsoever for any loss or damage caused by any act or omission taken as a result of the information contained in this publication. The articles does not take into account the investment objectives, financial situations and specific needs of recipients. The recipient of this publication must make its own independent decisions regarding whether this communication and any securities or financial instruments mentioned herein, is appropriate in the light of its existing portfolio holdings and/or investment needs.

This document is a marketing material and has been prepared by individual(s), marketing and/or research personnel of CFC. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is purely a marketing communication. In this publication, any opinions, news, research, analysis, prices, or other information constitute is a general market commentary, and do not constitute the opinion or advice of CFC or any form of personal or investment advice. CFC neither endorses nor guarantees offerings of third party, nor is CFC responsible for the content, veracity or opinions of third-party speakers, presenters, participants or providers. CFC will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on such information.

Charts, graphs and related data or information provided in this publication are intended to serve for illustrative purposes only. The information contained in this publication is prepared as of a particular date and time and will not reflect subsequent changes in the market or changes in any other factors relevant to their determination. All statements as to future matters are not guaranteed to be accurate. CFC expressly disclaims any obligation to update or revise any forward-looking statements to reflect new information, events or circumstances after the date of this publication or to reflect the occurrence of unanticipated events.

Staff members/employees of CFC may provide/present oral or written market commentary or analysis to you that reflect opinions that are contrary to the opinions expressed in this research and may contain insights and reports that are inconsistent with the views expressed in this publication. Neither CFC nor any of its affiliates, group companies, directors, employees, agents or representatives assume any liability nor shall they be made liable for any damages whether direct, indirect, special or consequential including loss of revenue or profits that may arise from or in connection with the use of the information provided in this publication.

Information or data provided by means in this publication may have many inherent limitations, like module errors or lack accuracy in its historical data. Data included in the publication may rely on models that do not reflect or take into account all potentially significant factors such as market risk, liquidity risk, credit risk etc.

The use of our information, products and services should be on your own due diligence and you agree that CFC is not liable for any failure to achieve desired return on investment that is in any manner related to availing of services or products of CFC and use of our information, products and services. You acknowledge and agree that past investment performance is not indicative of the future performance results of any investment and that the information contained herein is not to be used as an indication for the future performance of any investment activity.

This publication is being furnished to you solely for your information and neither it nor any part of it may be used, forwarded, disclosed, distributed or delivered to anyone else. You may not copy, reproduce, display, modify or create derivative works from any data or information contained in this publication.

Services offered by CFC include products that are traded on margin and can result in losses that exceed deposits. Before deciding to trade on margin products, you should consider your investment objectives, risk tolerance and your level of experience on these products. Trading with leverage carries significant risk of losses and as such margin products are not suitable for every investor and you should ensure that you understand the risks involved and should seek independent advice from professionals or experts if necessary.