Algorithmic Trading

Introduction

Nowadays, the integration of computing into the corporate sector has been a major concern for business establishments. In fact, this issue has been a top priority for most organizations since the second half of the twentieth century. With this in mind, it is worth noting that these trends have been maintained over the last few decades due to the development of algorithmic trading. Better known as algo trading, it encompasses commerce schemes that are heavily dependent on mathematical formulas and the ability of the computer to determine trading strategies. The introduction of this feature to the corporate field has made it simpler to take part in trading activities. According to the study conducted by the American Trade Council, the number of individuals investing in the stock market has more than doubled in the second half of the last decade. In fact, algorithmic trading is an essential activity in the trade sector that has undergone several phases of optimization for prime efficiency.

Economic Implications of Algorithmic Trading

Back Testing

When the computer programs aiding algorithmic trading are created, the coding is based on absolute rules. Precisely, the system does not make a random decision since all the parameters refer to a definite environment. Owing to the fact that the software integration to the trading sphere makes the entity a hard system, backtesting can be done. The term refers to the application of trading rules to the data in the historical aspect to determine the efficiency of an idea. According to Chan, the backtesting feature is quite similar to “what if analysis” commonly used in weather forecasts. It is worth noting that the set of rules in backtests minimizes the possibility of the user carrying out impulsive trade operations. In fact, it allows the traders to fine-tune their trade concepts thus preventing non-productive initiatives. Consequently, algorithmic trading is essential in the maintenance of a steady economy.

Productivity Enhancement

Effective trading requires one to be fast in getting in and out of trade relationships. According to the study conducted on the trade patterns in 2012, it was discovered that millions of dollars can be made or lost in a few seconds. In fact, it was reported that close to two hundred thousand people in active trading had been affected by these trends during that year. Consequently, there is a need to embrace faster decision-making in trading operations. Since computers quickly analyze and respond to the changes in the market trends, they are able to generate multiple trade orders immediately after a trading criterion is met. As a result, they have a great impact on the trade outcome. With the development of algorithmic trading, it became possible to create a protective stop order to prevent large losses. It is largely attributed to the fact that the programs are able to validate the impact of trade on the user’s income. When a company incurs a certain percentage of losses, the system automatically exits from the trade, thereby preventing massive losses.

Widening the Trading Scope

Unlike human beings, computers can scan for trading opportunities, monitor trades, and generate orders from a particular range of markets. Consequently, they can permit the user to employ various strategies to trade in multiple accounts. It prevents losing profit positions as well as spreading risks related to finances. Jean argues that the algorithms used in the creation of trading programs are rather dynamic and easy to update. When new changes are detected with regard to the patterns in the market, the system is able to incorporate the changes making it possible for the user to easily get in and out of a trade. It would have been exceedingly demanding for human beings to achieve that without the use of special software. Nonetheless, due to the convenience offered by the algorithmic trading systems, this can be effectively executed in a few seconds. Without a doubt, the advancement in software and hardware architecture to meet the needs of the trading system has resulted in several improvements in the trading sector.

Risk of Mechanical Failure

Apart from the positive impacts algorithmic technology has had on the development of the economy and the preservation of the trading culture, it is worth noting that it also has a negative influence on the sector. For instance, mechanical failure of the automated systems overseeing the trade processes could lead to large financial loss. Owing to the fact that the economy can grow or downfall each second, the failure of the systems could lead to the failure of the global economy. According to Kendall, the theory behind the success of the automated trading systems makes it seem like the algorithmic trading machines are infallible. Nonetheless, it is worth noting that once the connection to the remote server is lost, the trader faces problems. A survey conducted in 2013 revealed that close to five hundred thousand traders were many times the victims of network failure or machine breakdown. When this happens, it affects both the economy and trade culture. It is, therefore, irrational to rely on the internet or good performance of the computer when it concerns finances.

Constant Monitoring Affects People’s Productivity

Algorithmic trading has largely reduced people’s productivity. Owing to the fact that the market segment is volatile and trade can be affected in a matter of seconds, there is a need to constantly monitor the system to ensure that one does not suffer massive losses. Monitoring the progress of the automated system reduces the time one should invest in the activities that are more productive. As a result, there is a mediocre performance from the traders in spite of the fact that they can make the most out of a single trade operation. Moreover, there is a possibility that the system could malfunction thereby making errant orders or exiting the trade when it is not supposed to. Based on this perspective, it is evident that algorithmic trading reduces the efficiency of the trader as it takes a lot of time to monitor the performance of the stocks. This negatively affects the economy as traders could engage in other productive activities in addition to trading.

Constant Updates Adding to the Complexity of the Software

Just like any other software, algorithmic trading systems require constant updates from the developers. It is largely attributed to the fact that the systems need to be frequently advanced to meet the needs of the trader and the market demands. When this happens, the system becomes more complex. According to Robert, many people make trading errors misinterpreting the functions performed by the software. Conducting an erroneous trade affects the economic stability of a trader and thus impacts the economy of a nation. This has a similar effect on the trading culture and political system. Apart from that, users make numerous changes to the algorithmic trading system to raise their chances of making the most out of a transaction. When numerous optimizations are made, the system becomes complicated, and making simple alterations could result in massive losses. Consequently, this has a negative effect on the economy and trading culture.

Cultural Implications of Algorithmic Trading

Enhancement of Consistency in Trading

Trading rules are imperative for achieving maximum productivity from taking part in certain trade activity. Just like the operating system has a set of guidelines to oversee how it handles tasks, the algorithmic trading program is run based on the specific rules to enable the user to make the most out of the software. According to Major Benefits of Algorithmic Trading, the lack of trading rules places the trader at a 90 percent risk of losing the amount he trades. In fact, traders that do not see the essence of a trading plan cannot be regarded as skilled traders. In spite of the fact that having a trading plan places one in a better position to make productive ventures, there is no assurance that a trade would be 100% effective. There is a chance that an individual can make a trading blunder and repeat the same mistake in another transaction. Algorithmic trade software offers consistency in trading. Owing to the fact that it gives the user an overview of the trades they made in the past, the trader is in a better position to make productive decisions. Consequently, algorithmic trading creates consistency in trading.

Enhancement of Trade Discipline

Algorithmic trading ensures the maintenance of discipline when trading. In case there is high volatility in the market, the system establishes and performs trade ventures automatically. According to Hoang, discipline can be lost due to emotions in the trading environment. In fact, this claim is supported by the research conducted on traders’ behavioral patterns in 2014. It was determined that most traders are rather impulsive after a trade thus being capable of causing harm to both other people and themselves. Nonetheless, algorithmic trading averts the fear of facing a loss or the desire to make a little more return as a result of a successful trade. It is largely accredited to the fact that the trade plan is keenly followed regardless of the outcome. Furthermore, since the automated systems monitor trade on behalf of the user, there is no possibility of selling extra shares when one wants to buy a few shares. Undoubtedly, algorithmic trading preserves trade discipline.

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Minimization of Trade Emotions

If there were no algorithmic trading, there would be numerous trading errors. In simple terms, emotions would dictate people’s rationality when taking part or exiting a trade. According to Kendall, emotions and impulsiveness have been recorded to have been the primary cause of ineffective decisions during trading. In fact, people tend to believe that preserving through a decision they made in the first place could turn out successful regardless of the losses they face. Nonetheless, automated trading systems minimize the emotions likely to affect a trader at the decisive moments. Keeping emotions under control, it is easier for traders to follow the guidelines of their plans. This limits impulsiveness and paves the way for more productive trades. Algorithmic trading also helps traders that are afraid of getting into the business to make the decision as well as limits those with a high tendency of joining and exiting certain trades. As a result, algorithmic trading maintains the trading culture and enhances the stability of the economy by minimizing distractions such as emotions from the trading process.

Conclusion

In conclusion, algorithmic trading has an immense impact on the political, economic, and cultural sectors of society. Owing to the fact that the system is subjected to numerous improvements, it is constantly optimized to suit the needs of the user and the dynamic market. Besides, it automates most of the actions that ought to be made by a trader thereby making the trading process friendlier. Nonetheless, it has some negative impact on the productivity of the traders since it is involving and needs a lot of monitoring. The systems are very efficient since they have been transforming the stock trading systems. In fact, algorithmic trading is essential in the trade sector and has been undergoing several phases of optimization for prime efficiency.