Algorithmic Trading. What is it and how it works

If you are just starting out in trading, it is very likely that you do not know what algorithmic trading is all about. There is a very confusing and distorted idea of ​​all this and that is why I have decided to create this article.

You will see that it is not as complex as it seems and that in the middle of 2022 it is the order of the day and you can carry it out yourself.

1. What is algorithmic trading?

Algorithmic trading consists of trading through algorithms. Let’s start with the easy, what is an algorithm?

According to the RAE, an algorithm is an ordered and finite set of operations that allows finding the solution to a problem.

Ok, basically when you trade manually what you do is follow a trading plan or a buy or sell strategy of the type “if X happens, I execute Y”. This can be developed using an algorithm to run automatically.

2. How does algorithmic trading work?

I have already told you that an algorithm is based on processes and logic. Well, a process can be as simple as “from Monday to Friday, ring the alarm at 8 in the morning to go to work” or it can be much more sophisticated with artificial intelligence and machine learning.

This is nothing more than telling you that there are algorithms for trading that can be simple and others more complex. What will it depend on? Whatever you want to automate. If what you want to do is a simple action, the algorithm will be simple and if you want to complicate it, you can do it to unsuspected limits (I don’t recommend it).

3. Why apply algorithmic trading? Advantage

Comfort? Fashion? There is something more important and serious behind all this. It’s about working with numbers.

✔ Algorithmic trading allows you to make a backtest strategies and evaluate their results. This way, you eliminate what doesn’t work and keep the systems that are profitable. But it is also that it allows you a degree of fairly deep knowledge of what is happening in your trading such as: number of hours where your system usually enters and exits, maximum historical loss, expected performance… in short, a lot of variables that you should know as a trader.

✔ Another advantage is the app. If you apply automated trading strategies, you can execute them at the same time without the need to go crazy or be in front of the screen. Don’t get me wrong, it doesn’t mean you don’t have to do anything as a trader, but you can do more with less.

✔ Another plus, the precision. The human being is good in many things, but in the precision of your operations you will not beat an automated system. You will enter the market buying and selling when you have to, at the exact moment.

Peace of mind. You minimize emotions and don’t mess it up. You are sure that you are doing what you have to do and that your famous psychotrading is not interfering.

Freedom. We could define it as time, since you do not have to be constantly in front of the screen to continue trading. But I think that something broader is covered, such as freedom, since you have to spend time developing, testing and putting strategies to the test, but you can define when you do it. You can do it over the weekend without affecting your performance, traveling or going to the doctor without interfering with your business.

scalability. You can apply it to different accounts, assets and temporalities. Adjust the risk to a % of your capital and grow without having a limitation in terms of only managing one or two accounts. You can also apply different strategies at the same time in different assets and temporalities.

All these aspects of algorithmic trading are just the consequence of the main goal: to trade more professionally.

4. The worst of algorithmic trading. Disadvantages

When you create automated systems and apply them, whether you like it or not, you have a technological dependency. That the connectivity or the broker you are using does not fail. Although there are tools to limit all this, the risk is there and it is good to comment on it.

Another important thing is that when the systems close negative operations, your head will try to send you the signal that you manually or discretionally you could do better. Something quite debatable.

5. Trading robots don’t work

When we talk about a robot, don’t see it as something strange, they are simply called that because it replaces what a person can do. But remember that it has been created by a person and that it is only a few lines of code for a computer to understand and execute.

“I bought a robot that blew my account, trading robots don’t work”. This is quite a common thing.

What happens in this case is that just as we can automate something wonderful, we can automate a trading system that is a disaster. The vast majority of trading robots you can buy online are martingales with very sexy curves. The problem is that it is only for a very limited period of time. If you do a good backtest over a long period of time and look at the float of the account, you will realize the reality: they delay losses and there is a moment in the market that ends up burning your account.

But this does not happen because it is a trading robot, it happens because the strategy applied by the robot is a disaster. Also because of the approach of whoever buys it. Who believe that they are going to get rich overnight without having the slightest intention of how the robot works.

I’m going to say it very clearly: if what you automate sucks, you have automated shit. If what you automate is good, you have something that is constantly working well for you.

6. Automatic Trading vs. Manual Trading

Do I need to do algorithmic trading yes or yes to be profitable and make money? The answer is no. algorithmic trading it is not the infallible formula to earn money.

Algorithmic trading is a methodology to do things well, methodically and maintain an objective and real approach to things. That allows you to do things professionally and organize yourself in terms of time and space.

The direction in the industry is this, but this does not mean that trading discretionally you cannot be profitable. What works works, there is no more. There is no one foolproof way for everything.

7. High Frequency Trading (HFT)

Many people confuse speed with bacon when it comes to algorithmic trading and associate it directly with HFT. The High Frequency Trading or high frequency trading is a type of operation by some institutions that consists of making operations in less than a second.

It is somewhat popular because at times the amounts they move have caused the market to turn and it has been published in the media. Do not associate algorithmic trading with HFTthe latter is just a very concrete and specific practice.

8. Platforms for algorithmic trading without programming

Is it possible to do algorithmic trading if I don’t know how to program? A few years ago I would have told you emphatically no. But today there are platforms that allow the development and testing of trading systems no need to develop or code. You can use platforms to create systems that already export it to you in mt4 or mt5 to directly apply it to your broker. Also others like Tradestation, Multicharts or Ninjatrader.

The market has turned to automated trading in the last decade and banks, institutions and companies have invested a lot of money here. That is why today there are many platforms to develop algorithms and put them into operation in a very basic way.

9. Algorithmic trading strategies

As I have already told you, algorithmic trading strategies are nothing more than trading strategies that we translate into a code.

Now, how can you create your first strategy?

There are tools that make your life easier

10. How to start algorithmic trading

If once you get here you want to continue learning, I’m going to leave you a algorithmic trading course that I am uploading to YouTube in video format.

Also a free class on how to create winning strategies where I teach you how to do all of this from scratch.

I hope this article has helped you shed some light on all of this. If this has been the case and you think that someone close to you can help, share it. Many things are said about this topic and most of them are not true.

Hug and thanks for reading again.

Leave a Comment