Algorithms are often blamed when it comes to explaining high volatility, a surprising rise or fall in the markets. But what is really going on? Let John Plassard explain you more about algorithmic trading and the extend of its use.
Good morning and welcome to Weekly Insights.
Algorithms are often blamed when it comes to explaining high volatility, a surprising rise or fall in the markets. But what is really going on?
Firstly, you should know that Algorithmic trading is an automated trading approach that uses computer algorithms to trade the markets.
These algorithms create buy and sell orders (when the right conditions are met in each case) and automatically send the orders to the market via the brokerage platform.
For the trading algorithm to place an order, the market conditions must match the predefined criteria for an order entry per the trading strategy the algo is based on.
From spotting the trade setups to executing and managing the trades, the entire process is automated.
Secondly, the use of computer algorithms for trading has been on the rise in the U.S. equity markets since the turn of the century but seems to have plateaued around 70-80 percent in the last 5 to 10 years.
As of 2003, algo trading accounted for only about 15 percent of the market volume, but between 2009 and 2010, more than 70 percent of U.S. trading was attributed to trading algos.
The foreign exchange markets also have active algorithmic trading, which is measured at about 80 percent of orders in 2016 — up from about 25 percent of orders in 2006.
The value is much lower in emerging economies. For example, in India, the overall trading volume of algorithmic trading estimated is roughly 40 percent.
Nothing beats a fundamental approach to the markets, while being well aware that some market movements are induced by "robots".
Thank you very much. Have a great week, stay safe and keep on winning.