Since 2008, under the surveillance of trading bodies like SEBI, automated trading has been operational in India. Since then, the number of firms using algorithmic trading has been on the rise.
In
developed markets like the US, 70-80% of trading owes to algorithmic trading.
This opens paths for a bright career in algorithmic trading in Asian countries
where the market tends to be much more exciting as the concept is relatively
new compared to developed markets.
Here
are some little-known facts about algorithmic trading:
Prerequisites
before you start algorithmic trading
Various
stock exchanges have different prerequisites before you can get an approval to
start algorithmic trading. One can choose to be a trading member and directly
trade through the exchange by fulfilling the stated criteria. The members of
the exchange(s) apply for approval directly while the non-members apply through
brokers. Anyone eyeing a change in algorithms must have the exchange’s approval
before implementation.
Co-location
and its role in the market
The
first one to react to news is the one to use it to their advantage. In the race
to be the fastest to respond, most high-frequency trading firms rent space on
server racks on the same network right in stock exchange premises. This is
called as ‘Co-location’. The best benefit is reduced latency, i.e., time a
system takes to respond to trigger compared to those who have servers away from
the exchange. The concept is, data travels a lot lesser distance and results in
a faster response. Co-location leads to more efficient market due to decrease
in bid-ask spread, as market makers respond much faster to new updates and
afford to quote much higher prices.
Types
of Algorithmic strategies
Not every algorithm is designed for high-frequency trading. Institutional investors design various algorithms to trade in similar markets using. Some of the popular algorithms include:
- Momentum/Trend Following
- Statistical Arbitrage
- Machine Learning-based algorithms
The
order-to-trade ratio helps monitor the market.
The
order-to-trade ratio is the ratio of the total number of orders sent to the
exchange, to the number of orders traded. A ratio of 2:1 indicates that only
half of total orders were traded and the other remained pending or were
rejected. The importance of this ratio is that the exchange penalizes firms
with high order to trade ratio. Thus, while trading order-to-trade ratio needs
to be kept in mind while trading our orders!
Research
tools and Strategy development
With
the support of online research tools, traders are increasingly looking out for
online resources and back testing platforms to improve trading models and
strategies. Some web platforms give traders access to market data and a
platform to build and analyze automated
trading strategies using the power of statistics &
computing.
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