What is Algorithmic Trading?
The term algorithmic trading represents two core ideas.
First, algorithmic trading is fundamentally based on a computer algorithm. This algorithm could be simple, say, comparing two prices to see when they diverge by a certain amount. Or the algorithm could be more complicated using hundreds of real-time inputs and sophisticated mathematical modeling.
The second core idea is automation. Some people argue that algorithmic trading must be 100% automated to be considered algorithmic. I don't see it that way. I place more importance on the algorithm part than the automated part.
For example, suppose you have a system of ten servers collecting several megabytes of data per second, crunching the numbers in a sophisticated model and then posting trade recommendations to a screen where a trader then places the orders manually? To me this is still algorithmic.
Another example would be a retail trader who uses TradeStation or Ninja Trader to run a 100% automated trading system. Even if the algorithm is simple, this is still algorithmic trading.
Algorithmic trading systems may also be associated with high frequency trading because they are often leveraged for systems that require very fast response times, monitoring of a large number of data sources or complex calculations.
Compared to Systematic Trading
Systematic trading is based on the idea that a set of rules, or an algorithm, completely determines which orders to place with no additional human input. Therefore algorithmic trading qualifies as a subset of systematic trading.
The are many terms for the different trading philosophies and approaches. These terms overlap and are somewhat ill-defined, but here are a few more common ones.
- High frequency