How algorithmic trading works

How algorithmic trading works

What is algorithmic trading?

algorithmic tradingAlgorithmic trading is a way of executing and filling large orders. The reason for that is that the order is too big to be executed at once. Therefore automated programmed trading directives are used. These consider variables like volume, price and time and small portions are sent out to the market gradually. There, however, is also another definition…

Algorithmic trading is often also referred to automated trading systems or black-box trading. These are also often called trading robots or expert advisors you can use. Their goal is to assist you as a trader or solely make profit. They comprise trading strategies that depend on complex mathematical formulas. Often high-speed computer programs play a vital role as well.

Such automated trading systems may run your strategy automatically like intermarket-spreading, market making, trend following, arbitrage, martingale, grid strategies, hedging, scalping, news trading, level trading, neural networks or multicurrency trading for forex. Nowadays a lot of algorithmic trading systems are high-frequency trading systems which aim for a high order-to-trade ratio and a high turnover.

Overall algorithmic trading (also known as algo-trading) offers some advantages you as a human trader can’t achieve like trading speed and frequency.



An example of algorithmic trading

Imagine you as a forex trader want to currency pairs with the following trading rules.

  • You open a 0.01 lot buy position of that currency pair when the MACD (moving average convergence/divergence) goes above 0 and you close the position after 10 pips of profit.
  • And you open a 0.01 lot sell position of that currency pair then the MACD (moving average convergence/divergence) goes below 0 and you close the position after 10 pips of profit as well.

Here you’ll find how the MACD is defined:

With these simple instructions a computer program will track your price of a currency pair and automatically execute the orders whenever the criteria for opening and closing an order are fulfilled. You as a trader don’t have to monitor the prices in real-time by yourself and enter orders manually. It will be all done automatically by the automated trading system, by algorithmic trading.


What are the pros of algorithmic trading?

algorithmic trading program

  • The psychology of you as a trader is eliminated. There are no emotions, no fear, no panic, no greed. Greed might only turn up if you as a trader set the variables of your algorithmic trading system to greedy.
  • Algorithmic trading can be backtested by using historical data. By doing so you can check if your desired trading strategy is feasible and sound. Here you can see how backtests of a trading robot can be conducted:
  • Your risk of placing wrong manual trades is reduced. The program does always the same due to your entered variables.
  • You can apply your algorithmic trading system to a lot of currency pairs or other instruments. Your trading robot may check also for a variety of market conditions. For example can you apply the same trading robot multiple times on the same currency pair or instrument checking various conditions that are good for you to open or close a position.
  • Discipline and consistency in your trading strategy! You follow your desired trading strategy.
  • Manual intervention is still possible. In case your exposure or number of open trades increases significantly or you analyse that your running into a high level of risk you can still close positions and stop the algorithmic trading system.
  • Trade orders are placed accurately and instantly.  You can even define how much slippage or spread you are willing to accept.
  • Trades are executed instantly or due to your rules. At the best possible prices, of course, considering that there might be other algo-traders out there. But at least you are faster than the manuel traders using the same trading opportunity.


What are the technical requirements for algorithmic trading?

You don’t need to be a programmer or own a datacenter. In general you need the following to be an algorithmic trader:

  • A purchased trading robot or software, a skilled hired programmer or own programming skills.
  • Internet connectivity and access to a broker or a trading platform.
  • Access to market data feeds so that your algorithmic trading software can analyze the market all the time.
  • The capability and software to backtest your trading robot to check if it does what you want including the relevant historical data of the instruments.

You can find an overview of what you basically should have for automated forex trading here: