Thursday, 14 January 2010

Algorithmic Trading

Thousands of day traders earning a living from arbitrage opportunities in Indian stock markets may become extinct in the next few years, thanks to the accelerating interest in algorithmic trading.

In electronic financial markets, algorithmic trading or automated trading, also known as algo trading, black-box trading or robo trading, is the use of computer programs for entering trading orders with the computer algorithm deciding on aspects of the order such as the timing, price, or quantity of the order, or in many cases initiating the order without human intervention. There could be thousands of codes written to buy or sell a security, currency or commodity at a particular level when one or more factors emerge.

Algorithmic Trading is widely used by pension funds, mutual funds, and other buy side (investor driven) institutional traders, to divide large trades into several smaller trades in order to manage market impact, and risk. These programs are so fast that people, who look at various developments and decide trade, would be left behind because a machine has done it in milliseconds.

Algorithmic trading may be used in any investment strategy, including market making, inter-market spreading, arbitrage, or pure speculation (including trend following). The investment decision and implementation may be augmented at any stage with algorithmic support or may operate completely automatically ("on auto-pilot").

Example of Algorithmic Trading: A program could be to sell the stock fortunes of a particular company and buy the stock, if the fortune price is x% higher than the stock price. Also, it could be to compare a set of variables – if rupee is more than 45 to the dollar and crude oil is less than $60 per barrel, then software would sell Infosys futures and buy HPCL shares.

In 2006 at the London Stock Exchange, over 40% of all orders were entered by algo traders, with 60% predicted for 2007. National Stock Exchange (NSE) has approved applications of about 200 of its members to trade using algorithms.


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