Taking the Risk: is Algorithmic Trading the Right Choice for You?

Let me start off by reminding you today that there are no guarantees when it comes to trading. Sometimes everything points to something going one way, until it turns around suddenly and does the opposite instead. This is what makes trading an advanced science, even an art to some, rather than a formulaic system.

Algorithmic trading leverages the speed and emotion-free capability of a computer program to execute trades. These programs can process information and make decisions in milliseconds, giving the kind of speed in trades that a human could never compete with.

Can Algorithmic Trading Work?

Yes, of course it can, otherwise it wouldn’t be such a hotly debated topic, would it? Common sense tells us that it’s impossible to have a 100% success rate, yet there are certainly many traders out there who’ve made a fortune from algorithms.

The thing is they aren’t making money because of algorithmic trading, they’re making it because of good decisions, good trading skills, and the creation/use of a good algorithm. The fact that they use algorithmic trading allows them to make more money in less time, while potentially limiting their losses.

Notice I said potentially – if the algorithm is a bad one it will struggle to make money and losses can be bigger than usual!

What is an Algorithm?

Algorithmic trading programs work based on a formula. This formula is the set of criteria/instructions used to make trades, and can be altered by you. The formula is otherwise known as an algorithm.

There are many pre-made algorithms available to you, many of them with customization options so you can tweak them for your own uses. Of course if you’re an advanced user, you may want to create your own algorithm. Again there are programs available to simplify this for you, or you can go the more in-depth route and do the work yourself from scratch.

With many traders lacking programming skills, it’s often best to use a professionally available program or to hire a good programmer of your own to do the technical work for you.

Should I Use Algorithmic Trading?

The real question you need to ask here, is am I a knowledgeable and experienced trader? If so, you should have a good enough understanding of your markets to use an algorithm effectively. Enter the field gently so you don’t over-extend and gradually increase your positions and exposure over time.

For those without the necessary experience an algorithm can be an easier way to learn. It could simplify the details for you, though be aware it isn’t going to magically make you a better trader. It’s just a simpler way of learning how trading works.

Outside of that there is also the factor of your fund size, and how many trades you can execute. Algorithms work best with high-frequency trading, because they focus on making small amounts on each trade. The pay-off is in the huge number of trades these programs can execute over time. If your fund can’t afford many trades at a time, it may cause a bottleneck which limits you. This could be avoided by focusing on cheaper trades where you can increase your volume instead.