The Pros and Cons of Algorithmic Trading

More than half of Americans (56%) report that they own stock in the stock market. Buying and selling any security is an excellent way to build an investment portfolio and save for the future.

Yet most take part in manual stock trading, where people make decisions about entering and exiting trades.

With the rise of computer technology, algorithmic trading is becoming more popular for investors to execute trades. Is it worth giving algorithmic trading software a try?

Let’s discuss the pros and cons to see.

What Is Algorithmic Trading?

Algorithmic trading is when you make trading decisions based on pre-set conditions. You program these conditions into a computer.

Then, traders and investors can write code or create a trading algorithm to execute trades when the conditions are met.

You can base conditions on things like:

• Price
• Time
• Volume

You can use algorithmic trading to trade several different securities, not just stocks. For example, automated futures trading is common as investors speculate on the price of commodities, such as crude oil or corn.

Advantages

Automated stock trading has several benefits. The first is that it minimizes market impact.

When someone makes a large trade, it can change and distort the market price. Therefore, investors need to buy smaller amounts of shares in batches and evaluate the impact of the trade after each purchase.

But this can incur significant transaction costs and take hours to complete.

With algorithmic trading, the computer can automatically check if the purchase disrupted the market. This will reduce the number of transactions, and the time it takes to complete large trades.

Further, automated trading helps to remove emotions and ensure rules-based decision-making. It’s easy to get caught up in a bull market and ignore trouble signs.

Algorithms help investors adhere to their set rules. This preserves discipline and allows investors to achieve consistency with their trading plans.

Finally, automated trading can help diversity your trading. You can trade from different accounts and use several strategies at once. This helps to spread out risk across different securities and create a hedge against losing positions.

The immediate response to changing marketing conditions also helps mitigate risk.

Disadvantages

As with anything based on technology, mechanical failures are possible. For instance, if a trade order is on a computer, not a server, you could lose the trade if the Internet connection goes down.

There could also be discrepancies between theoretical trades and actual trades. A learning curve comes with using automated trading systems, so starting with small transactions will help.

Automated systems still require monitoring. You can’t turn on the computer and leave it to work all day. Anomalies happen that could result in errors.

It’s also possible to over-optimize your plan. You may create a system that looks awesome but performs poorly. “Perfect” plans seldom succeed.

Start Trading

Algorithmic trading is a great way to make lucrative trades with minimal effort if you have coding knowledge. Consider the pros and cons discussed in this article, and decide whether you’re ready to give it a try.

To learn more about investing, check out the rest of the blog. We add new content daily for our readers.