The biggest problem with decision-making is that the same decision may be hard to make when you’re under pressure. It’s like performance anxiety, where you know the right answer, but once you’re in a spot where you have to actually make it, it seems more difficult than you originally expected it to be.
However, what if you could program this decision-making so that, when the conditions are met, the decision is made automatically? In this scenario, you can chart the optimal course in advance and completely skip any dilemma once the time comes to actually pull the trigger.
This is the so-called algorithmic trading, where you set up all the conditions (the algorithm) which allow your trading profile to know how to behave under certain circumstances. For all those who are interested, here are a couple of things worth knowing about algorithmic trading.
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Stock Market Behavior
While the behavior of the stock market isn’t always predictable, you would be surprised at just how often some patterns reoccur. This is why even some of the most veteran traders are so focused on stock chart patterns. As a matter of fact, there are a lot of charts that are so common that they have their own names. An ascending triangle, a descending triangle, a flag, a wedge, and a pennant, are just some of the examples.
Whatever you choose to do, there’s always a list of homework you need to complete in order to do it effectively. Every online money making project regardless of trading or hosting a blog takes some research.
One of the main reasons why this happens is due to the fact that you’re not the only one looking at these charts, and you’re not the only one making decisions. Specific events, a political crisis, for instance, will usually cause a dip in people’s trust in organizations, which will lower the value of various stocks. The same will increase the value of precious metals. In other words, the majority of people are making the same decisions under the same circumstances, and this is something that an algorithm can be programmed to recognize in the early stages.
Now, keep in mind that a chart pattern is nothing more than a visualization of data, which is why it’s really not that hard to program a trading platform to recognize it and act on it. Seeing as how similar conditions often give similar results, this form of algorithmic trading is a lot more reliable than many of its alternatives. The key thing worth keeping in mind is that this doesn’t guarantee gains, but it does make them more consistent.
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A Chance to Test Your Strategy
One of the greatest advantages of algorithmic trading lies in the fact that you have a chance to test your strategy before committing resources to it. There are two common methods:
- Out-of-sample testing
- Backtesting
Now, the first method involves withholding a portion of sample data at the moment of building the model. Then, you get to see whether the omitted data was predicted accurately by your algorithm.
The second model is backtesting. Due to the fact that we live in a world where we have virtually unlimited access to previous data, you can test your strategy in a historical setting. This way, you can see the outcome in a matter of seconds and see how you would fare. For instance, if you decided to buy based on the recognized flag chart pattern the last time it appeared for a certain stock, would this be a good decision or a bad one? With backtesting, you don’t have to guess. You can see for yourself.
The Biggest Benefits of Algorithmic Trading
Previously, we’ve mentioned that automation of your decision-making puts less pressure on you and makes things somewhat easier to handle. Well, while this is the main reason why some people choose to go with algorithmic trading, it’s definitely not the only reason. The list of benefits of algorithmic trading is quite long. For instance:
- Trades are executed at the best possible price
- The transaction cost is reduced
- Trade executions are instantaneous
- Automated checks are monitoring numerous markets
- The possibility of human mistake is reduced (manual error)
One of the biggest problems with old-school trading is that it’s just less efficient. Even if you create a stop order that won’t automatically place the trade but send you a notification, by the time you see the notification in question and make a decision some time will pass. This time may be critical, and if there’s no time to waste, there’s nothing that can beat automation in this regard. Also, you should never underestimate the likelihood that your finger will slip and push the wrong button at the wrong time.
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Supplementing Your Existing Strategy
The most important thing you need to understand about algorithmic trading lies in the fact that it’s not replacing you or forcing you to alter your strategy. The decisions are still yours – you’re just making them in advance.
- If X, Y, and Z happen, what would be your response?
This is how it all starts. Then, when these three (in this example) conditions are met in the real world, the response will be automatic. In other words, the choices are still yours, the decisions are still yours, and the strategy is still the one of your own choosing.
The difference is that you have all the time in the world to make these decisions rather than being forced to make them on the spot. The fact that there’s less pressure will make you see things more clearly and reduce the likelihood of critical oversight.
Also, as we’ve already mentioned in the previous section, all of these decisions get an instant execution. It means that when the conditions for your decisions are met, the order will be sent right away, and (depending on the latency) it will be executed in a matter of milliseconds.
To make the long story short, this is not an alteration to your trading strategy – it’s an upgrade.
In Conclusion
In the end, algorithmic trading is just a fancy term for automating your decision-making process while trading. Almost every serious trading platform offers this service in one form or another. So, it comes down to you to learn how to use it and to set your parameters. Sure, it’s a bit of extra work, but it saves you a lot of time in the long run, and the benefits that come with it are worth it.
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