The Secret Of Algorithmic Trading
The use of computers for trading purpose is called algorithmic trading
. The algorithm of the computer decides on what orders has to be placed, price of the trade, quantity of the trade etc. It is mostly used for trading pension funds and mutual funds. It is also used to divide the large trades into smaller trades. It is also called the High Frequency Trading as the computers make decisions such as initiating the orders according to the information received from the markets. Even before the information reaches the person the algorithm of the computer find outs and initiates the trade. Hence, it is called high frequency trading.The Algorithmic trading system uses the advanced models of mathematics for making decisions for trading. The rule with which the model is built determines the time taken for placing an order and the impact that it will cause. The trading is usually done in bulk blocking of shares and dividing them into smaller blocks. The complex algorithm decides when the purchase of smaller blocks has to be made. The principal strategy behind the High Frequency Trading is that the HFTs use passive orders that stay in the limit and do not spread until they are cancelled or filed. This feature allows the HFTs to profit from the rebates and bid ask spread. The profits got here offsets the losses occurred due to the providing liquidity for the traders who drive the stocks directionally. The HFT strategies are based on actively crossing the spread and consuming liquidity.
The main goal in actively providing liquidity is to be on top of the stocks of the order book. If you are bidding at the top of the stock and got hit, the remaining order supports the bid price. If the hit is made when you are at the bottom of the stack, then the price paid will become a new offer. Therefore, it is a disadvantage to be at the bottom of the stack. The HFTs are perplexed by the negative insinuations made against their market behavior. They prefer short term strategies; have trading with low latency matching engines; have security and allow rick control; automated markets with its advantages over the human market are some of the features. The HFT strategies perform better in the volatile markets. The high volatility correlates to the high volumes and high volumes means more profits. Though the profits increase, the liquidity that is provided via the passive orders dampens the volatility.
The main risk of the High Frequency Trading is the inventory management. Traders usually have large traders who have a significant size of the help move the risk. The ways this risk can be controlled is by keeping the net exposure low and diversify among various securities. Technology failure can also be managed by building redundancy systems. The HFTs are based on the real time trading and are focused on the risk management. The challenge for any HFT is another HFT. The space for the entry of an HFT is very low and the cost for it is also not very high. The HFTs are low margin and high volume business. The profit per trade is low per share whereas for a long term investor the profits are greater per share. All said and done the future of the HFTs is said to be extremely bright.
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