Algorithmic trading

Algorithmic trading or automated trading is also know as Algo, Black-Box or Robo trading. It represents the use of electronic platforms for entering trading orders (such as Long and Short) with an algorithms that are deciding on aspects like timing, price or quantity of the order and initiating the orders without human intervention.

Hight Frequency Trading (HTF) is a special class of algorithmic trading in which application makes decisions and initiates orders automatically. Decisions are based on electronically received informations before human traders even process the information they observe. This kind of trading dramatically change the microstructure of market, particularly in the liquidity way.

According to Aite Group (Financial services industry research), in 2006, third of all United States and Europen Union stock trades were driven by automated applications (algorithms).

Of course, one of the main issues regarding Algorithmic Trading is difficulty in determing how profitable is this kind of trading. In August 2009, TABB Group (Financial Services industry research firm) released a report estimating that 300 securities firms that specialize in Algorithmic Trading took (roughly) US$21 billion in profits in 2008.

HFT and Algorithmic Trading become the subject of public debate since the "US Securities and Exchange Commission" along with "Commodity Futures Trading Commission" said that they contributed to some of the volatility during the "2010 Flash Crash" when the Dow Jones suffered second largest intraday point swing ever to that date (though prices has been quickly recovered).

Algorithmic trading Strategy's

Algorithmic strategies are implemented by using modern programming languages. Increasingly, the algorithms that are used by larger brokerages and asset managers are written to the FIX Protocol's Algorithmic Trading Definition Language (FIXatdl). It allows firms to receive orders and exactly specify how electronic orders should be expressed. Orders that are built using these algorithms can be transmitted via FIX Protocol.

Some of strategies that are used by Algorithmic Trading are:

  • Trend following - Here system aims to work on market trend mechanism and take benefit from both sides of market, enjoying the profits from ups and downs of the stock or futures market.
  • Pair Trading - A market neutral strategy that enables traders to profit from ant market conditions: uptrend, downtrend or sidewise movement. It is categorized as "Statistical Arbitrage" and "Convergence Trading Strategy".
  • Delta neutral strategies - In finance, it describes a portfolio of related financial securities. Portfolio's value, due to small changes in underlying security, remains unchanged. Such portfolio contains of options and their corresponding underlying securities such positive and negative delta components offset, resulting in the portfolio's value being insensitive to changes in the value of the underlying security.
  • Arbitrage - Is the practice of taking advantage of price difference between two of more markets. Also, when used by academics, an arbitrage consists of transaction that involves no negative cash flow at any state and positive cash flow in at least one state. In simple terms, Arbitrage is the possibility of risk-free profit at zero cost.
  • Mean Reversion - A mathematical methodology sometimes used in stock investing but it also can be applied to other processes. Idea is that, deviations from the average price are expected to revert to the average.
  • Scalping - Represents a method of arbitrage of small price gaps that are created by the spread of bid and ask. This method requires quick position establishing and liquidating, usually within minutes or seconds.

Most of the Algorithmic Trading strategies belongs to "cost-reduction" category. Mainly because large orders are broken down into smaller orders and are entered into the market over time. This is basic strategy that is also called "Iceberging". An algorithms that are designed with main purpose to find hidden or "Iceberg" orders are called "Stealth" (developed by the Deutsche Bank).