If the Forex market gives the investor the opportunity to make money, he faces another big problem. That is the problem of predicting which the market movement. The market is fluctuating all the time due to the social and political movement. The exact nature of the movement is difficult to predict. But, if one uses computerised programs to predict the movement of the market one does not have to worry at all. This type of trade execution we call as algorithmic trading or Algo trading.
Advantage of the Algo Trading
Algo Trading thus removes the biggest problem the trader faces namely prediction. This automated software does not need any human intervention. This removes the human error completely. High-frequency trading is a subset of Algo trading. In this type of trading, we see buying and selling of thousands of shares in fractions of a second.
Algorithmic trading in India began in 2008 following the directive by the Securities & Exchange Board of India (SEBI) to allow Direct Market Access (DMA) facility. This allowed the institutions to execute buying and selling orders without any intervention from the brokers. The institutions will still use the trading interface supplied by the brokers but the access to the exchange trading system will see no manual intervention from the broker. TO understand Algo trading, one must develop a perspective. Using the perspective one can make better trades. We can do this by studying the categories present in Algo trading. Algo trading uses trading strategies that we classify into the following:
- Statistical Arbitrage
- Momentum
- Market Making
- Arbitrage
Statistical Arbitrage
This kind of arbitrage opportunity arises due to misquote of prices and lasts for a short duration only. This is because the market adjusts the price very fast. Use of algorithmic trading strategies helps us track these events and use them. This involves the use of statistics and so it is a misconception that does not last long.
Momentum
This is the way the market heads due to the history. If you use software to study the market movement, you will notice a trend. This is the momentum which lasts for a long time, say for a week or two. You can base your trading strategy on the momentum and this gives you a profit whenever you are right.
Market Making
This occurs due to those market makers or liquidity providers who quote a buy and sell position in any financial instrument. They hope to make a profit on the bid offer spread. The securities get liquidity due to this market making process. Securities that do not see much market movement will benefit by the action of the market maker. The profit that the market maker makes depends on the amount of risk that he takes.
Arbitrage
This is an event based strategy that exists in the market. Any event will trigger a movement in the prices. Suppose a company A is going to acquire company B and the acquisition is a positive one, then this will cause the value of the shares to increase. Suppose the acquisition is negative, it will cause the value to fall. So, the person who reads the event correctly will make money due to the event.
