Algorithmic trading is the use of computer programs and software to open and execute transactions based on predefined rules such as price movement in an underlying market. Trading algorithms (algos) can execute a buy or sell order on your behalf if the current market circumstances fit any specified criteria, saving you time by removing the need to manually search the markets.
The advantages of Al-based trading
There are numerous advantages when it comes to automated trading. First and foremost they allow access to any investor, with or without experience which is an awesome starting point for beginner traders. On top of that utilizing trading, robots allow traders to do complex processes and execute different strategies in a simpler and faster way and operate in different markets and with different types of assets.
Another advantage of algorithmic trading is its accurate precision. When an AI executes a transaction automatically, traders can avoid the dangers associated with human trades, such as mistakenly entering the wrong deal. When compared to a computer program that has been carefully verified to ensure the proper order is submitted, manual submissions are considerably more likely to buy the wrong currency pair or for the wrong amount.
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The risks associated with Algo trading
Though there are numerous advantages to trading with algorithms, there are a set of risks for every trader to think about and take into consideration.
Incorrect Algorithms
A flawed algorithm can lead to errors in transactions and market manipulation, resulting in millions of dollars in losses in a relatively short amount of time.
High volatility
When algorithms react to changes in market circumstances, they may widen the bid-ask spread or stop trading, resulting in excessive volatility and a reduction in liquidity.
Chain reaction
Because global markets are highly integrated, a slowdown in one market spreads to other markets and asset classes, causing a chain reaction. (As in the subprime mortgage crisis)
Lack of transparency: The trader is unable to observe the algorithms as they are run, resulting in disparities in expectations and outcomes.
Lack of transparency
The trader is unable to observe the algorithms as they are run, resulting in disparities in expectations and outcomes.
Lack of Knowledge
Because brokers provide many algorithms, the buy-side lacks the ability to determine which algorithms would be best for their portfolio. This also lowers the quality of algorithm evaluation.
Imbalances in the market
While few traders can afford sophisticated equipment that executes orders, the majority still trade manually. This generates market fragmentation, which leads to liquidity in the short run.
The difference between traditional and Robo trading
As mentioned earlier Robo-advisor is simply a computer algorithm that manages investments instead of a human being. While removing the human aspect may appear frightening, it also reduces expenses. Robo-advisors work on the assumption that users would most likely utilize a buy and hold strategy and that asset allocation is the primary determinant of portfolio success.
When it comes to humans managing your trading or you doing your trading yourself, there are different advantages such as you having more leverage and control over your assets and how you want to allocate them. But on the other side of the spectrum, humans will never be able to match the super speed of the algorithm. So in the end it all comes down to a preference, but every professional is going to say that it is best to diversify your portfolio as much as possible and have different expert advisors and have a real human being trading for you as well or start trading yourself.
