Algorithmic Trading – Why Professionals Are Reaping Record Profits
Algorithmic trading, or automated trading, has always been the preserve of top Wall Street traders. Banks and large hedge funds use supercomputers for entering trading orders with powerful algorithms, which execute pre-programmed trading instructions. This style of trading is widely used by investment banks, pension funds, mutual funds, and investor-driven institutional traders to make tremendous profits in a matter of seconds.
Now, the technology is better, cheaper, and faster than ever before enabling Main Street retail traders, like you and me, to leverage a style of trading that has historically been reserved for the big boys on Wall Street.
While, computerization of the order flow in financial markets began in the early 1970s, full electronic execution developed in the late 1980s and early 1990s. Then, in 2001, a team of researchers at IBM published a paper that showed two algorithmic strategies could consistently out-perform human traders. And, over the last decade, as more electronic markets opened, other more powerful autotrading strategies have been developed.
Algorithmic Trading Strategies
There are many different types of algorithmic trading strategies that are being effectively employed throughout the world, including:
- Trading Ahead Of Index Fund Rebalancing – Most retirement savings in the US are invested in mutual funds, and in particular, index funds which must periodically rebalance their portfolio to match the new prices and market capitalization of the index they track. Algorithmic traders anticipate this and trade ahead of the price movements cause by the rebalancing.
- Trend Following – Algorithmic traders who use trend following strategies do not forecast or predict specific price levels. They simply initiate a trade when a trend appears to have started and exit the trade once the trend appears to have ended.
- Pairs Trading – Typically, this is a long-short, market-neutral strategy that enables traders to profit from transient discrepancies in relative value of close substitutes. In theory, this algorithmic strategy should work regardless of market direction. However, in practice, execution risk and declines in volatility can make this strategy unprofitable for long periods of time.
- Delta-Neutral – Algorithmic strategies in this category generally combine options and their corresponding underlying securities such that the positive and negative delta components offset, resulting in the portfolio’s value becoming relatively insensitive to changes in the value of the underlying security.
- Arbitrage – This is the practice of taking advantage of price differences between two or more markets. One of the most popular trading opportunities is taking advantage of the disparity in the pricing between the S&P futures and the S&P stocks.
- Mean Reversion – This is a mathematical methodology that is often used for stock investing. When a stock’s current market price is less than its average price, it’s considered attractive for purchase with the expectation that prices will rise. Various stock reporting services commonly offering 50 and 100 day moving averages.
- Scalping – This is an arbitrage method that takes advantage of small price gaps created by the bid-ask spread. Scalpers will attempt to buy at the bid and sell at the ask to gain the difference, even when there is no price movement at all.
Key Books About Algorithmic Trading
Here are some great books that delve into the details of developing strategies for algorithmic trading:
- Quantitative Trading: How to Build Your Own Algorithmic Trading Business (Wiley Trading) – Ernest Chan
- Algorithmic Trading and DMA: An introduction to direct access trading strategies – Barry Johnson
- Option Volatility & Pricing: Advanced Trading Strategies and Techniques – Sheldon Natenberg
- Volatility Trading – Euan Sinclair
- Trading and Exchanges: Market Microstructure for Practitioners – Larry Harris
How You Can Get Start With Algorithmic Trading
There are several ways to get started, and there are pros and cons to each. Two of the most popular ways are:
- Create Your Own System From Scratch – Obviously, this is the most difficult method. But if you have your own manual trading system that has been a consistent winner, you might consider this. Most traders don’t currently have the programming skills required for this, so this usually requires an experienced programmer. Some traders have found good resources on sites such as Elance, Guru.com, RentAcoder, or oDesk. However, experienced programmers are usually very expensive, and the amount of time to develop the system and test it to ensure all the bugs are resolved can take months, if not years.
- Using A System Developed By Someone Else – This is by far the quickest and easiest way to get started with autotrading. The advantage of starting with this method is you can review the long-term profitability of the trading method. You are also able to get started immediately.
Your Next Step – An Invitation To Learn More
If you have ever wanted to automate your own trading strategy or see what you should look for when considering an automated strategy, join me in an upcoming webinar where I share the process we went through in developing an automated strategy that has outperformed the S&P 500 by 8x for several years running.
I will open my own personal trading account and show you my ACTUAL TRADING RESULTS from the last two years where I have consistently made profits week after week with virtually no chart time.
These are “must-attend” events, and I strongly recommend you check one of them out. I have not seen anyone else teaching this.
So go head, and register your seat right now while you’re thinking about it.
I’ll see you there,
– Dustin Pass