Algorithmic Trading

Advanced

Algorithmic trading is the use of computer programs to place trades automatically according to pre-set rules, based on factors such as price, timing, volume or mathematical models.

Algorithms can analyse markets and execute trades far faster and more consistently than humans. They are now responsible for a large share of trading in many major markets.

Algorithmic trading has many uses. Institutional investors use execution algorithms to split large orders into smaller ones over time, reducing their impact on prices. Market makers use algorithms to quote buy and sell prices continuously. Quantitative funds use them to follow trading strategies based on statistical patterns. High-frequency trading, a subset, aims to profit from very small price differences over fractions of a second.

For example, a pension fund wanting to buy 2,000,000 shares might use an algorithm that buys in small amounts throughout the day, matching the market's average price.

Algorithmic trading has improved liquidity and lowered trading costs, but it raises concerns. Programming errors or interactions between algorithms can cause sudden price swings, as in the US flash crash of May 2010. Regulators require firms to test algorithms, apply risk controls and keep records.

For worked examples and full lessons, visit notesbysara.org.