The UK is no stranger to financial markets; in fact, the history of modern trading can be traced back to the city of London. However, over recent years trading has become more sophisticated and utilizes complex computer algorithms (algorithmic trading) designed to seek out market opportunities, exploit them and quickly bounce back from unfavourable positions.
What is algorithmic trading?
Algorithmic trading is an automated pre-programmed trading instruction that accounts for variables like time, price, and volume. This form of trading attempts to exploit computers’ computing power and speed compared to human traders.
Algorithmic trading is used by investment banks, hedge funds and other large financial institutions worldwide because it enables transactions to be processed faster than before. It had developed significantly since its introduction in the 1970s when computers were expensive assets that small investors could not afford.
The algorithm uses advanced mathematical principles to sift through reams of data in minutes with the purpose of spotting trends before they occur. The information is used to recognize market opportunities in fractions of a second, allowing traders to capitalize on them before others have had time to process what has happened.
This can be highly profitable in trading financial instruments such as currencies, commodities and shares. However, with great reward comes even more significant risk; the algorithms are designed to spot trends but do not usually take into account sentiment, resulting in trades made against the trader’s interests.
Algorithmic trading platforms can also recognize when markets are about to move against positions by executing an automated stop-loss order that closes out ranks quickly for minimal loss. This means that funds cannot be easily stolen from accounts because most professional algorithmic trading software will shut down trading if it detects unusual behaviour.
Algorithmic Trading Pros
- Fully automated trading is fantastic for passive investment.
- It protects against many of the blunders that investors often make.
- Computers and their software never close their eyes. You can research and monitor the financial markets 24 hours a day, seven days a week.
- The most adaptable trading system will allow you to customize your trading systems to meet your specific objectives.
- Demo accounts abound on most platforms, which you may use to experiment and master before spending real cash.
- A variety of signals or bots are available. Signals are for research and investors to act on once a year, whereas bots will follow the algorithmic regulations.
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The use of algorithmic trading is not without controversy, however. In 2010, “flash crashes” – sudden, significant falls in the prices of shares and other assets – occurred on several occasions, most notably when the Dow Jones Industrial Average lost 9% in just five minutes. Some commentators blamed algorithmic trading for these events, but an inquiry by the US Securities and Exchange Commission could not determine a definite cause.
A more recent example occurred in February 2015 when the Swiss franc suddenly appreciated by 30% against the euro after the Swiss National Bank (SNB) removed its currency peg. Many traders who had bet that the franc would weaken were left with significant losses as their positions were rapidly closed out at a loss.
Despite these events, algorithmic trading continues to grow in popularity as investors worldwide look for ways to gain an edge over their competitors. In the UK, the Financial Conduct Authority (FCA) has been working hard to ensure that traders use safe and effective software and understand the risks involved.
Algorithmic trading is now an integral part of the financial industry which has, for better or worse, become increasingly reliant upon such software to handle transactions as they happen. Thanks to advancements in technology, it’s always possible to improve; without this, simply maintaining market share would be extremely difficult.