My Perspective on Algorithmic Trading (Part 1)

Where oh where should I possibly begin when it comes to algorithmic trading?

Let’s start with a definition. Wikipedia says algorithmic trading is:

      > A method of executing orders using automated pre-programmed trading
      > instructions accounting for variables such as time, price, and volume.

High-Frequency Trading (HFT) is a subset of algorithmic trading. More specifically, HFT is characterized by high speed, co-location, and frequent trading (high turnover). Co-location means trading computers are housed on the same premises as exchange servers to minimize delays and get the best execution (prices). HFT [presumably] uses complex algorithms and [presumably] sophisticated tools to trade.

I say “presumably” because I am unable to directly verify this. You probably can’t, either. We can read articles, blog posts, watch CNBC interviews by “industry insiders,” and potentially talk to industry representatives ourselves [e.g. IARs, quants we meet at dinner parties, or principals of financial firms that we casually encounter (how?)], but most of these people cannot escape inherent conflicts of interest. We are left to choose whether or not to believe (and to what extent). While I do believe select individuals have a bead on the truth, that’s not me and I’m not afraid to admit that to myself or to you. I’ll get back to this in another post because it really never gets old and is always applicable in the world of Finance (lest you doubt, watch more American Greed).

I don’t want to approach anything when it comes to investing or trading without having my critical analysis faculties (i.e. bullshit detector) at the ready. Remember the original post on optionScam.com?

For me, algorithmic trading carries two main implications. First, trading strategies can be programmed and executed by computer. This can free me up to do a multitude of other activities. Second, algorithmic trading takes the emotional component out of the equation. Fear and greed can lead to overtrading or failing to take trades. Algorithmic trading takes trades every single time they’re supposed to be taken.

These implications are not without some very important caveats, and I will begin discussion of these in the next post.