Algorithmic trading strategies – which are also known by the monikers algo trading, automated trading and black-box trading- utilize a computer program to follow a distinct set of instructions to enter or exit a trade. The trade, in theory, can generate profits at a speed, as well as frequency, that is unfeasible for a human trader.  In addition, trades can be placed in many different markets simultaneously, which no human trader could reasonably do.

The distinct sets of instructions in a trading algo are based on timing, cost, quantity, indicators, patterns or really any arithmetic model, as long as it can be programmed. Separately from revenue opportunities for the trader, algo trading offers markets more liquidity and volume. For traders, one benefit is that algorithmic trading allows for more logical decision making – by reducing the impact of human emotions on trading activities.

Advantages of Algorithmic Trading

Successful Trading Strategies offer the following advantages:

• Speed And Accuracy

Trade order placement is immediate and accurate.  In the old days, especially in the futures trading pits, a trader would first call the broker, give the order over the phone, and then wait for 1-10 minutes to find out if he received a fill.  Even then, at the end of the day, sometimes fill prices would mysteriously change, as the floor participants tried to match trades.  It is funny, but I remember fill changes almost never working in my favor.  I wonder why that was – LOL!

Today’s markets are all electronic, and have dramatically reduced the possibility of errors in trades.  Most of the errors I encounter in trading these days are of my own doing!

• Trade Timing

In the days of old, a trader would sit down at night, look at a chart, draw some trendlines, perform calculations of standard indicators and then place buy and sell orders for the next day.  Speed was not a consideration – everyone traded off of daily charts, and usually flooded the market with orders at the open.

In 2021, this is a different trading world.  Traders use algos to make instantaneous decisions on all sizes of bars, not just daily bars.  Speed – rapid calculation, rapid order placement, rapid fill notification – is all part of the algo trading progress.  In fact, it is definitely one of the major benefits.  Money can be made (or lost) more quickly than ever.

• Reduced peril of manual errors when placing trades

As mentioned earlier, in the old days you had to enter order via phone.  So there was a lot of opportunity for errors.  In the current markets, the chances for error rest almost solely upon the trader.  He or she is the one who enters the order, so is the one usually making the mistake.  That is why algo trading can be so powerful.  A properly programmed algo will not make “fat finger” mistakes or produce other shenanigans that manual traders routinely experience.

• Algo-trading can be back tested utilizing accessible historical and real-time data to see if it is a feasible trading strategy

This is a huge benefit of algo trading.  The theory here is that a strategy which is historically profitable is likely to remain profitable in the future.  Of course, there is no guarantee here.  After all, the US government wisely warns traders “past performance is not indicative of future results.”  That is absolutely true.

So how can one develop an algo strategy that performs well historically AND (more importantly) in real time?  That is a million dollar question, one algo traders have been striving to answer for many years.  It almost seems easier to create a losing algo strategy than it is to create a winning one!

For example, if you were to take a strategy, program it in a trading platform like Tradestation, and optimize a few of the parameters, you could get a great looking back test – maybe something like the equity curve shown below.