An algorithm is a specific set of clearly defined instructions aimed to carry out a task or process. And there are instances when a human trader isn’t able to handle enormous numbers of trading, and that’s when you need intervention of an intelligent algorithm.
Algorithms have gained popularity in the trading landscape and many big clients demand it. These mathematical algorithms analyze every quote and trade in the stock market, identify liquidity opportunities, and turn the information into intelligent trading decisions.
Algorithmic trading (automated trading, black-box trading, or simply algo-trading) is the process of using computers programmed to follow a defined set of instructions for placing a trade in order to generate profits at a speed and frequency that is impossible for a human trader. Any strategy for algorithmic trading requires an identified opportunity, which is profitable in terms of improved earnings. The algorithmic trading strategies are based on timing, price, quantity or any mathematical model. Apart from profiting opportunities for the trader, algorithmic-trading makes markets more liquid and makes trading more systematic by ruling out emotional human impacts on trading activities.
Suppose a trader follows these simple trade criteria:
Buy 100 shares of a stock, when its 100-day moving average goes above the 200-day moving average
Sell shares of the stock, when its 100-day moving average goes below the 200-day moving average
Using this set of two simple instructions, a computer program can be written that will automatically monitor the stock price (and the moving average indicators) and place the buy and sell orders when the defined conditions are met. There is no manual intervention required here. The trader, no longer has to monitor the live prices and graphs, or place orders himself. This algorithm does his work for him every efficiently.