Many individuals have been interested in using algorithm trading to increase their portfolio returns, but it can be difficult to know where to start. Newly-emerging algorithmic trading strategies provide a way to optimize trading performance, while minimizing risk and improving overall investment strategy. This article will provide an introductory overview of the different strategies and approaches available to the novice trader, aiming to help them make the most of their financial investments.
What is Algorithm Trading?
Algorithm trading is a relatively new type of trading that uses automated and pre-programmed trading instructions to make decisions about buying and selling stocks, bonds and other financial instruments in order to generate profits. It is a combination of computer programming and trading analysis, relying heavily on mathematical and analytical models. It generally follows certain set rules, taking into account both technical and fundamental indicators in order to decide which actions to take.
How Can Algorithm Trading Assist Trading Performance?
Algorithm trading can be a valuable tool for a novice trader or investor, allowing them to take advantage of opportunities that may not have been apparent or accessible to them otherwise. By using mathematical models and automated trading software, they can make informed, timely decisions without having to become intimate with ever single financial instrument.
Algorithm trading also encourages disciplined decision making and helps traders of all skill levels stay the course. It can be helpful in reducing emotional or psychological bias that a trader may have and makes sure the trades are in line with the set rules or parameters.
Different Types of Algorithm Trading Strategies
Risk-Based Algorithm Trading
Risk-based algorithm trading is an efficient way to manage risk and optimize portfolio returns. This strategy considers an individual’s risk appetite when creating trades, taking into account that over-trading may increase risk. The algorithm will decide when to enter or exit the market, choosing only optimized trades that match the risk tolerance of the trader.
Arbitrage Algorithm Trading
Arbitrage algorithm trading looks to take advantage of small price discrepancies between assets listed on different exchanges. This strategy will compare prices in multiple markets and wait for a moment of misalignment in order to buy and sell assets simultaneously. Any profits generated by this method will be the result of price discrepancies rather than the appreciation of the underlying security.
Momentum-Based Algorithm Trading
Momentum-based algorithm trading adopts the premise that stocks that are trending in a certain direction will continue to do so, at least for a certain period of time. The idea behind this strategy is to try and determine which assets are moving in which direction and will play an important role in identifying stocks that have the potential for solid short-term gains.
Final Considerations
Algorithm trading can be an ideal strategy for the novice trader, as it helps simplify and streamline the process of making trading decisions. By using the right combination of algorithms traders are able to control risk, capitalize on opportunities and make informed financial decisions. As with any trading strategy, algo-trading should be approached carefully and with caution. Though it can be incredibly useful, it is important to understand the underlying mechanisms and make sure they are able to provide a consistent return on investment before using them in practice.
