Algo trading sometimes referred to as algo, may be defined as computerized trading that employs proprietary algorithms or pre-programmed commands that are tailored to take into consideration variables like price, volume, and timing.
First introduced in American financial markets in the 1970s, algo-trading is generally utilized in trading scenarios such as arbitrage, trend trading strategies, and order execution while approximately 60% of all trades were executed by computers in 2010.
Today, algo trading can be classified into the following two categories: Algo Execution Trading occurs when an order (generally a large order) is conducted via an algo trade.
Since algo programs are engineered to secure the best possible price, algo execution trading may divide the trade into smaller fragments and place trades at varying times.
You can think of algo execution trading as performing a set order trade.
High-frequency trading (HFT) is a style of algo trading that seeks to capitalize on small trading opportunities within the market, where tens of thousands of trades can occur per second.
Type of Algo Traders
Algo trading provides traders with a more systematic trading approach as opposed to manual trading while the majority of algo trading occurs in the form of high-frequency trading.
Given the versatility of algo trading, it is used by a myriad of traders.
Short-term traders tend to gravitate towards algo trading where arbitrageurs and brokerage houses not only benefit from automated trading execution but also by the generation substantial liquidity created through algo trading.
Algo trading performed by medium to long-term traders tend to acquire large sums of stock where traders aim not to cause disturbances or volatility with anonymous, large-volume trades.
Trend followers, forex traders, and hedge funds use algo trading systematically to benefit from increased trade efficiency and through automated trade execution as opposed to instinctual-based investing.
Common algo trading strategies used include index fund rebalance, mean reversion, time-weighted average price, volume-weighted average price, and percentage of volume.