Algorithm Trading or Algo trading in India is gaining popularity with each passing day. The investors are always keen to make higher returns in the stock markets. In fact, if the returns can be made on an intraday basis, nothing better than that. However, intraday trading is a risky affair. Furthermore, it can lead to the destruction of capital employed, if right positions are not taken. Therefore, traders need to be more careful than the long-term investors. To help the traders, a mechanism that has evolved and used widely is Algo trading.
In this article, we shall understand the concept of Algorithm Trading or Algo Trading.
Meaning of Algo Trading Software
Algo trading is also known as an automated trading system. In algo trading mechanism, the computer system or the algo software follows a defined set of instructions to place trading orders. In addition, the algo software also helps to generate higher returns by placing multiple orders within seconds that is not possible for humans. Besides that, the Algorithm software also rules out the possibility of human emotions. Therefore, trading using the algo mechanism is more disciplined and practical.
Let us take an example of Algo trading to understand its functioning in a better way.
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Example of Algo Trading Strategies
Suppose a trader puts the following criteria in the algo software.
- Sell 50 shares of a stock when its price falls below the 52 week low.
- Buy 50 shares of a stock when its price goes above the 52 week high.
In the above scenario, the trader has given his trading instructions and put Algorithm strategies. Therefore, when the price of a stock will go below the 52-week low, the algo software will automatically sell 50 shares. Similarly, when the price of a stock goes above the 52-week high, the algo software will automatically purchase 50 shares. Thus, we can see that the trader’s presence is no more required while trading. In fact, the orders are placed automatically when the stock fulfill the defined criteria. The trader no more has to track the live price or the graphs of the stock to find a trading opportunity.
Now, let us move ahead and see the advantages of using algo trading mechanism.
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Advantages of Algo Trading
- There is no risk of human errors because the orders are placed automatically.
- The trader does not need to track the live prices.
- The trades take place at the best prices.
- The transaction costs are reduced because human assistance is not required.
- A large number of orders can be placed in a quick span that is not possible for a human to do.
- The manual errors like placing of a wrong order or putting the wrong buy or sell figures are avoided.
- It keeps a check on market movement as well.
The above points reflect few of the benefits of Algo Trading.
By now, we have learned that algo trading is an important tool for traders. Nevertheless, other investors in the stock markets also use it. Let us see the type of investors who use Algorithm trading mechanism in the stock markets.
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Users of Algo Trading
- Regular traders or intraday traders are the primary users of the algo trading mechanism. In fact, the automated transaction helps in earning higher returns. It also creates good liquidity of the shares in the market.
- Short-term traders also use algo tool to get the benefit of automated and quick trade execution.
- Mid-term to long-term investors use algo tools to buy shares in the market. The long-term investors include mutual funds, insurance companies, etc.
Thus, it would not be wrong to say that algo trading mechanism provides an opportunity to all the types of investors. Therefore, they can put their money in the stocks that fall under their pre-defined guidelines.
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