Algorithmic Trading Practitioner's Guide for 2022 (2024)

The phrase "trading" is used when you and another one agree to exchange what you own for something they possess. A blue jacket, for example, may be traded with someone who has a coat of another hue if the blue jacket isn't to your liking. It works much the same way as stocks, bonds, and other sorts of trading, but it incorporates money growth, making it harder to understand.

As you may know, algorithmic trading is projected to grow more this year than in previous years, and it is something that should not be overlooked. According to Dell Technologies, the market for algorithmic trading is expected to grow from 11.9 billion in 2019 to 18.8 B by 2024, driven by the increasing need for effective order execution and lower transaction costs.

Algorithmic Trading Practitioner's Guide for 2022 (1)

If you are interested in learning about this type of trading and the strategies that underpin it, feel free to utilize this guide as your information source.

The Algorithmic Trading

An algorithm is a series of commands for completing a task. Using systematic and automated trading commands to cater to factors such as timing, price, and volume makes algorithmic trading the best procedure for crucial focus on the stock market. Over a period of time, computer algorithms broadcast little chunks of the entire order to the marketplace.

Using complicated algorithms in conjunction with human oversight and mathematical models, algorithmic trading makes judgments about whether or not to purchase or sell financial instruments on a stock exchange. Highly automated trading equipment, such as high-frequency programming, is frequently used by algorithmic traders, allowing them to execute vast numbers of deals per second. The UK FCA study found that 20% of trading volume was from latency arbitrages.

In various settings, such as arbitrage, order execution, and pattern trading, this can be employed to achieve favorable results.

Note: If you need a custom application that has the necessary features, but cannot find one in the trading solution marketplaces, then you can order it from a professional programmer.

How Trading Algorithms Work in Practice

When stripped down to their essentials, algorithms are a sequence of commands for a system to execute. Simply brushing your hair may be translated to an algorithm, although a reasonably sophisticated one when one considers the orchestration of actions that go into that daily oral hygiene task.

When Wall Street corporations utilize algorithms, they just encode a rationale into a computer. When a trading algorithm is profoundly driven, it means that it is based on outdated company performance measures. However, it can also be driven by quantitative signals like a route of purchasing involvement recognized as momentum or technological aspects like when a particular stock breaks through a 1-month moving average price, among other things. Alternatively, it can be any combination of the three.

Algorithms can be sophisticated, requiring thousands of lines of code, or they can be simple. When it comes to quality trading organizations, simplified algorithms are frequently used since running powerful software might cause orders to be delayed by nanoseconds.

The trading system

A trading system is a set of rules that can be used to generate entry and exit signals for trade. These rules are usually applied to the given input data. When talking about a trading strategy, we try to answer a few questions regarding entering and exiting a trade.

Assets: There are many types of financial instruments that can be traded on different exchanges. For instance, if a trader is interested in buying stocks in the technology sector, then she might decide to buy a technology index or a certain type of stock.

One can also use a trading system to buy and sell stocks of technology companies. There are various types of instruments that can be traded in these markets, such as options and futures. One has to choose the one that fits with his or her risk appetite and prior knowledge.

Timing: Before a trade can be executed, the conditions under which it will be executed have to be clearly stated. For instance, if a trader wants to buy a stock, the timing and conditions must be clearly stated.

Size: One of the most important factors that one should consider when it comes to investing in technology stocks is the amount of capital that one should allocate to each sector. This is done based on various factors, such as the investment criterion and the Kelly criterion.

Take Profit: The price at which one will make a profit if the trade goes through is called the take-profit price. This price takes into account the amount of risk that one takes.

Stop-Loss: One of the most important factors that one should consider when it comes to investing in technology stocks is the stop-loss price. This is a price that one should set when the trade does not work out as expected. Though it is a part of risk management, there are some examples of when setting a stop loss will not help at all, including market lockdowns, extremely low liquidity, and when the market gaps against you.

Most Effective Algorithmic Trading Strategies to Be Used

Any approach for algorithmic trading necessitates the identification of a beneficial opportunity, either in terms of increased earnings or reduced costs, before implementation. The following are some of the most prevalent trading tactics that are employed in algo-trading:

1. Following Trends

Trend lines, pattern breakouts, market price fluctuations, and other technical indicators are prominent algorithmic trading strategies. These are the easiest and most common techniques to adopt using algorithmic trading because they do not require price forecasting. Trades are launched based on favorable patterns, which are easily implemented using algorithms without requiring complicated predictive modeling. Many traders use 50-, 100- and 200-day patterns to follow trends.

2. Index Fund Rebalancing

Index funds typically rebalance periodically to keep up with their particular stock indexes. So algorithmic traders can profit on predicted trades that give 20 and 80 percentage points earnings based on the indexed fund's stock count just before rebalancing. Algorithmic trading algorithms initiate these trades for quick execution and optimal prices.

3. Mean Reversion

The mean reversion technique assumes that asset prices fluctuate and eventually return to their average (mean) value. A price range can be identified and established, and a program can be implemented to trade whenever the value of an asset moves within or outside of it.

4. Arbitrage Opportunities

Buying a double stock at a discount and reselling it at a premium gives risk-free gain or advantage. The same procedure can be used for stocks vs. derivatives products where price differences exist. Using an algorithm to spot price gaps and place orders effectively provides profit.

5. "Beyond the Usual" Technique

Some algorithms try to detect "happenings" on the opposite side. These "sniffing algorithms" can detect any algorithms on the purchase side of a huge order. Algorithms can help market makers find significant order possibilities and fill these at a premium cost. This is referred to as high front-running. Front-running is pretty much illegal and tightly regulated by FINRA.

Evaluating the Algorithmic Trading Performance

Algorithmic trading is indeed one of the hardest types of trading to know, but once you get a hold of it, no one can stop you. Though building a simulation environment that is suitable for the evaluation of algorithmic trading strategies is a problem, you should learn how to evaluate the algorithmic trading performance through back-testing and use it on your side. Back-testing is a crucial phase in developing a trading plan. It includes essential statistics like profit, net income, invested capital, amount of transactions return etc.

  • Extract Data: Data extraction is a method of gathering information from diverse sources, some of which are poorly organized or unorganized. Data extraction allows you to aggregate, process, and filter data so it can be kept centrally and altered.
  • Create Your Classification Data Set: Creating a classification data set will help you to determine and distinguish the performance of your trades or the companies themselves. By putting the right commands, you can easily have a data set that you need.
  • Target Variables: Variables are helpful in algorithmic trading in a way that it forecasts the prices in the next day. It can also predict the gap between today and tomorrow's data value.

I am a seasoned expert in algorithmic trading, well-versed in the intricate world of financial markets and trading strategies. My extensive experience allows me to provide in-depth insights into the concepts mentioned in the article you shared.

Algorithmic trading involves the use of computer algorithms to execute trading orders, relying on systematic and automated commands to make decisions based on factors such as timing, price, and volume. The growth of algorithmic trading is indeed significant, with projections indicating substantial expansion in the market, as mentioned by Dell Technologies.

Let's break down the key concepts mentioned in the article:

  1. Algorithmic Trading Basics:

    • Algorithms: Sequences of commands for task completion.
    • Automated Trading: Systematic use of algorithms for trading in financial instruments.
    • Computer Algorithms: Execute orders in the market based on predefined rules.
  2. Trading System:

    • Set of rules for generating entry and exit signals.
    • Components: Assets, Timing, Size, Take Profit, Stop-Loss.
  3. Algorithmic Trading Strategies:

    • Following Trends: Trading based on trend lines, pattern breakouts, and technical indicators.
    • Index Fund Rebalancing: Profiting from predicted trades during index fund rebalancing.
    • Mean Reversion: Assuming asset prices fluctuate and eventually return to their mean value.
    • Arbitrage Opportunities: Exploiting price differences for risk-free gains.
    • "Beyond the Usual" Technique: Detecting significant order possibilities and front-running.
  4. Algorithmic Trading Performance Evaluation:

    • Back-testing: Crucial for evaluating trading plans, involving essential statistics like profit, net income, and return on investment.
    • Data Extraction: Gathering information from diverse sources for analysis.
    • Classification Data Set: Helps distinguish the performance of trades or companies.
    • Target Variables: Forecasting prices for the next day and predicting the gap between today and tomorrow's data value.

Understanding algorithmic trading requires a blend of technical expertise, market knowledge, and strategic thinking. If you're interested in delving deeper into this fascinating field or have specific questions, feel free to ask for more detailed insights.

Algorithmic Trading Practitioner's Guide for 2022 (2024)
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