Algo trading is now a ‘prerequisite’ for surviving in tomorrow’s financial markets.
Financial trading floors are experiencing a huge transition from innovative technologies. It has given traders more powers to do fast execution of trades with discipline in a rapidly changing market scenario by reducing human errors, as computer-programmed software remains unaffected by human psychology.
In today’s era, where more and more traditional traders follow technical charting for their trading calls, an algo trader finds it risky to depend merely on the findings gathered from an examination of charts and, thus, tries to reply on pure arithmetic.
Ten years ago, a financial institution would take a big trade on to its books, and would have a large number of traders try and execute deals in small chunks without moving the market. Today, many big trades are fed into computers running algo programmes, which then execute them automatically in small packets. The biggest advantage of programmed trades is their capability of spotting arbitrage opportunities between prices in split seconds and executing trades to make a profit even before a human trader blinks.
Algos have also been created to trade upon news, using special programmes to scan incoming agency reports for key words relating to, say, a change in interest rates and enact deals based on market responses to similar past events. Furthermore algos can analyse every quote and trade in the stock market, identify liquidity opportunities and turn such information into intelligent trading decisions. Here rules are pre-defined, back-tested and trades are placed at pre-defined levels.
In India, algo trading arrived in the financial markets when Sebi allowed exchange members to offer DMA (direct market access) to their institutional clients. Basically, investment banks and hedge funds with billions of dollars in AUMs (assets under management) are using algo trade to manage their portfolios in a more strategic manner. In India, they account for 35-40 per cent of total turnover on the exchanges.
Algorithmic trading has ushered in a new era for markets, whose benefits are yet to be fully realised. Adapting to this new means of trading can ensure better results. Algo trading is now a ‘prerequisite’ for surviving in tomorrow’s financial markets, because the future of trading and dealing is in automation.
Industry reports suggest global algorithmic trading market size is expected to grow from $11.1 billion in 2019 to $18.8 billion by 2024, expanding at a compound annual growth rate (CAGR) of 11.1 per cent. Although algo trading outperforms traditional styles of trading on many counts, human intervention is still required to some extent for better market making with prudent thoughts to ensure stability in financial markets.