Today we are talking about something that might sound a little fancy but is actually an amazingly useful tool in the world of trading: algorithmic trading. It could seem like a term only a Wall Street pro or technologist would use, but stick with me—by the end of this article, you'll get the gist of what it is and how you can use it. In simple terms, algorithmic trading is the use of computer algorithms to automatically execute trades in financial markets. You have probably heard it called 'algo-trading' or occasionally ‘bot trading.’ It’s also sometimes referred to as 'black-box trading' when the algorithm’s logic is complex or proprietary, but at its core, it’s just about using computers to execute trades based on pre-set rules.
Imagine you're a stock trader, and you’ve got a strategy that tells you to buy a stock when its price drops by 5% in one day, and sell it when the price goes up by 10%. Normally, you'd be glued to your computer, monitoring the market, checking charts, and making decisions based on those price movements. It sounds like a lot of work, right? What if you wanted to watch dozens of assets, or base your decisions on complex statistical models?
Well, algorithmic trading takes that pressure off by using a computer program (the "algorithm") to automatically make these trades for you. You set the rules, and the algorithm follows them—buy when the stock hits your specified decision point, sell when it reaches your target, and so on. The beauty of algorithmic trading is that it's fast, efficient, and it can operate 24/7 without needing to take breaks like us humans!
Now that we know what algorithmic trading is, let’s dive a little deeper into how it works. Here’s how you can break it down into steps:
First, you create a trading strategy. This is where you decide on the assets you want to trade, and the rules you want to make up your strategy. These might be based on factors like technical indicators (e.g., moving averages, relative strength index), price patterns, or even complex mathematical formulas that analyze past data to predict future trends.
Traditionally, building an algorithm required coding in languages like Python, C++, or Java. However, a modern platform, like the no-code tools of Algo Pilot, allow you to create and test algorithms without writing code. That means you no longer need to be a programming genius to get started—you can create, backtest, and trade with algos; all without reading or writing a single line of code. More on that later.
Next comes backtesting, a critical step! Backtesting involves running your algorithm on historical market data to evaluate its past performance. However, keep in mind that past results don’t guarantee future success due to changing market conditions. Since you aren’t trading live at this stage, this is a no-risk way of testing your algo by war-gaming “what if” scenarios. It’s like testing your recipe before you serve it to guests. If the algorithm performs well in backtesting, great—if not, you can tweak it and test again. (Learn more about backtesting in this article we wrote on just that subject!)
Finally, you set parameters and go live with your algorithm using current market data. This is when you can let the algorithm do its magic. The software can place buy and sell orders via your broker on your behalf, according to the rules you set. But always keep an eye on it, especially at the beginning, to make sure it’s working as expected and is ready for changes in the market.
So you might be wondering: “Why go through all this trouble? Why not just trade the old-fashioned way?” Well, here are some reasons why algorithmic trading has become so popular:
There are many different ways to use algorithmic trading, depending on your goals and trading style. Some common strategies include:
If you're new to algorithmic trading and want to give it a shot, here’s how to get started:
Algorithmic trading might seem like something only for big banks, but the truth is, it’s becoming more accessible to everyone. Whether you’re a seasoned trader looking for more efficiency or a beginner just learning trading, algorithms can be a helpful and exciting way to automate and optimize your trading strategy. Start small, experiment with different asset types or indicators, and continuously monitor and refine your algorithms. While tools like Algo Pilot can simplify the process, always understand the risks involved in trading. Happy algo trading!
Algo PilotTM is a US based technology company and not a bank, broker-dealer, or RIA. As such, Algo Pilot LLC does not provide investment advice and is not a member, SIPC. Brokerage services offered by 3rd parties are not directly affiliated with Algo Pilot LLC, and Algo PilotTM users may choose the broker relationship that they desire. Algo Pilot's Algo Builder is Patent Pending with the USPTO.
Past performance, whether actual or indicated by historical tests of strategies, is not a guarantee of future performance or success. Investing in stocks, futures, options, currencies, cryptocurrencies, and other financial vehicles involves risk. Investing in securities involves potential loss of principal. Trading in options or security futures involves a high degree of risk and investors may lose more than their initial investment; options trading is not suitable for all investors. Before trading, please read all applicable risk disclosures such as Characteristics and Risks of Standardized Options disclosure from your broker.
