In an automated trading or algorithmic trading system, computer programs are developed to automatically trade securities on a stock exchange. These computer programs or applications are also called auto trading robots. Your Personal Financial Mentor always guide you in establishing a specific set of rules in a program for both trade entries and trade exits and these entries and exits can then be automatically executed by these trading robots. This system is often used by active traders who typically enter and exit positions at a comparatively much higher rate than an average investor. Trading robots are used in different markets including foreign exchange, stocks, future and options.
Automated trading provides an electronic platform to place your orders in the stock market. In the last few years, automated trading has developed a new trend in a stock market. Now you can trade your shares and execute the transaction in milliseconds. It was introduced by SEC’s Regulation Alternative Trading Systems in 1998, to compete against other stock exchanges. And since then, it is continually evolving. In recent decades, US markets have also changed from manual trading system to highly automated trade markets.
Automated trading has reduced the cost by automating hundreds of processes and its goal is to reduce the trade cost to zero, so that high transaction volumes do not abnormally increase the cost. It has also allowed companies at different locations to trade with one another successfully and hence, increased the market efficiency. Therefore, it introduced a greater competition by globalizing the trade market. A trader can now trade stocks and futures on LIFFE or Eurex at a single click. Increased transparency, tough competition and improved liquidity have tightened the spread. Spread is a difference between a buying and selling price of an instrument and represents a profit of a market maker.
With high-frequency trading, financial system can be managed more efficiently but a single mistake can turn into a disaster. High-frequency trading firms are facing many challenges and one of them is a severe drop in trading volume around the world in last four years. However, Chief Technology Officer and a vice president of Progress Software, Dr. John Bates said, “Firms that actively deploy high-frequency trading must not mistake this study for a validation that the practice cannot impact the market negatively”.
Automated trading is broadly based on backtesting. Backtesting is a technique to test trading strategies by applying them on historical data of a stock market. A trader determines the viability of his trading rules with the help of this technique. But it can only perform well in certain trade platforms and may perform terribly in live market because historical data is not a reliable measure to devise a trading plan. The stock market is continually evolving and a trading strategy of a trader may not be able to cope with the increasingly changing trends efficiently.
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