What is Algo Trading

As evident the word Algo Trading is derived from two root words algorithm+trading. An algorithm generally refers to the set of mathematical steps that we generally follow for any given process while trading simply refers to buying or selling of any stock in the market. To sum it up,

Algo Trading is a form of Automated trading that uses computer programs to analyse market data based on pre-defined parameters.

If the above definition is too difficult to interpret for you let me give you an example.

Let’s say I am interested in shorting(shorting is when a trader borrows shares from a broker and immediately sells them with the expectation that the stock price will fall shortly after.) a stock is soon as it started trending below -10 points from the day opening.

Without algo trading: If we manually execute the above trade we have to constantly keep an eye on the trading terminal and wait for this condition and then make sure we place the order exactly when my given condition triggers

With algo trading: Just write a piece of code or build software where we feed in our condition and let the code/software automatically check and place your trade at the time when the condition is triggered without any manual intervention.

Who should be doing Algo trading?

As we speak before we jump into the concept and nuances of algo trade we should be familiar with the concept and process of trading in a stock market. If an individual has never accessed a trading terminal or do not have a Demat account, it would not be a good idea to go for algotrading.

An Ideal audience for algo trading would be someone who has the knowledge and has executed trades in the past. After all, we are just automating our trading with rules and conditions that we follow while taking the trade manually. Take my personal case, I have a day job that does not allow me to constantly monitor the markets as I would want to, thereby I would prefer some kind of automation that can do the trading on my behalf.

Why algo trading makes sense?

I was watching an advert where Prateek Singh, the Founder, and CEO of LearnApp, says.

“Most traders fail to make money is stock markets, because they do not have a strategy”.

I will go on to add another sentence to it.

“Not only do they have a strategy, but they also cannot rely upon themselves to execute the strategy when triggered”

Discovering a tried and tested strategy that reaps 40% + annual return on your investment might be tempting, but having the calculation and formula on paper is one thing and being successfully able to execute it every time that formula is triggered across 53 weeks of trading can becomes extremely daunting.

Further, it's not just about one strategy, you can execute as many strategy as you can think of for as many stocks as you want. Imagine you have 10 strategies in mind for 10 different stocks. Trying to keep a tab on 10 stocks at the same time and executing those strategies will be impossible.

Pros and cons

Lets first discuss the advantages.

1. Removal of manual intervention will account for higher precision in terms of execution of the trades. The placement of orders is fast and accurate.
2. Automating your trade will help you increase your productivity. Given, you have automated your trade now you don't have to bother looking at the trading terminal. You can focus on your day job, take the guitar lessons that you had always planned, and play with your kids while your machine is doing the business for you.
3. Trading in the stocks market can be emotional. Sudden variations in the stock prices can often swing our manual decisions away from our normal strategies we might end up closing our trade early or late.

Now the cons:

1. Whenever we let algorithms take control of any of our activity, there’s an added risk of things going wrong due to a fault in the code or software. Imagine placing an order for 1000 quantities while you meant for 10 quantities and in case you end up in loss it can wipe out your quantity.
2. Building a system from the scratch is not everybody’s cup of team. You will need to the knowledge to code and the lesser your experience with code higher the chance of building an unstable system.
3. There’s an added cost and infra involved. For executing trades manually all you need is a mobile app. That’s it. For algo trading, you need a platform to code, and all the necessary software required for building your strategy.

How to get started

There are some softwares which you can explore. Example “Streak” from Zerodha is one software where you can deploy your strategies. But, their features are limited. I would still recommend exploring software.

But the real learning and the power of algotrading if one tries to learn and implement from scratch will require knowledge of one programming language and a trading terminal that provides an API. An API provides access to let us fetch prices, and buy and sell stocks through our code/software to the terminal.

Going forward, I will be posting a series of blogs in regards to algo trading.

I will be using

1. Python as the programming language.
2. Kite (Zerodha as the trading terminal).
3. Kite Connect API as the API to execute.

For more information stay tuned to this blog post. This is the first of many to follow

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