Algorithmic trading which is also known as Black-box trading, simply means that the systems are trained and provided with a certain set of instructions to perform trade with limited human interventions. It is theoretically conceivable for the trade to produce profits at a rate and frequency that are incomprehensible to a human trader.
Profits result best if the foundation of algorithmic trading strategies is built and implemented correctly. The specified sets of instructions are based on cost, timing, volatility, quantity, or any other statistical model. In addition to providing the trader with prospects for profit, algorithmic trading increases market liquidity and makes trading more organized by minimizing the influence of human emotions.
Each strategy is designed to provide accurate execution of algorithms to the trader for placing an order. It depends on the risk-bearing appetite of the trader.
What are Trading Strategies?
Algorithmic Trading strategies serve as a detailed roadmap for analyzing market conditions and making trades. Strategy is described as a combination of best practices to estimate price movements as well as a set of rules to determine when to enter and exit a trade.
A strategy for algorithmic trading relies on identifying a profitable opportunity that can allow investor to enhance their earnings or reduce their costs as a result of the strategy. Backtesting trading strategies, by obtaining a real-market data feed from the exchange is a crucial step in Algo trading. A trading order includes details including price, volume, time, and quantity.
To place a transaction, each strategy works according to its own set of principles. As algorithms are free from human emotions, they eliminate the risk and loss associated with greed and fear.
According to a report by Valuates Reports which predicted that “The global algorithmic trading market size was valued at USD 12,143 Million in 2020 and is projected to reach USD 31,494 Million by 2028, registering a CAGR of 12.7% from 2021 to 2028”
5 Popular Trading Strategies
A variety of approaches are used for forex algorithmic trading strategies to carry out the best possible trades. Trend trading, arbitrage, mean reversion, swing trading, and pairs trading are the most widely used strategies. Other strategies include market timing, transaction cost minimization, index fund re-balancing, and scalping. Although each strategy is unique, the process for carrying out Algo trading stays the same.
Following are the 5 popular trading strategies:
Trend Trading Strategy
The trend trading strategy is one of the simplest and most commonly used strategies, which is accessible even to new traders or beginners. In simple terms, trend trading strategies use trend signals to generate entry and exit conditions based on the stock’s trend. If the price continues in the direction of the trend, the trending trading strategy buys during an uptrend and shorts during a downtrend. Once the trend reverses, the trade is exited.
The use of algorithms to implement trades without getting into the complexity of predictive analysis allows traders to profit from the appearance of desirable trends.
The most common trend trading strategies that are designed and based on indicators are.
- Moving average crossovers,
- Relative strength index (RSI), and
- Average directional index (ADX).
Arbitrage opportunities take place when there is a price differential between the securities on various stock exchanges. This strategy suggests taking advantage of the financial instrument’s or asset’s mis-pricing in two different marketplaces. If you had purchased the asset for less money, you can now sell it for more money on the market. In this manner, you achieve financial success without having to assume any risk.
Due to price discrepancies, in this case, you can trade many assets at once for a profit without taking any risks. Since there are occasionally price differences between stocks and futures products, the same procedure can be repeated. Profitable opportunities are made possible by implementing an algorithm to find these price differentials and placing the orders effectively.
Additionally, the transactions should take place simultaneously to reduce market risk exposure and the likelihood that prices will fluctuate in one market before both transactions are finished.
According to the theory of mean reversion in finance, the prices of securities and other economic indicators like interest rates will typically return to their historical mean levels. The idea behind mean reversion is that an asset’s highs and lows prices are cyclical phenomena that periodically return to their mean value or average value. It entails determining a stock’s trading range and computing its average price using analytical methods.
Trading can be done automatically when a price crosses into or out of a defined range by identifying, defining, and putting into practice an algorithm based on that range. The recent price standard deviation of a stock is frequently employed as a buy or sell indicator. Using algos to trade around mean reversion is common.
In addition to providing excellent diversification, mean reversion strategies are often dependent on long-term trends in the market to provide an excellent long-term investment. You can also apply mean reversion strategy to existing portfolios of stocks to earn extra returns. By taking conservative leverage on your portfolio, you can improve your returns while taking on fewer risks.
Pairs trading is apparently a very popular trading strategy. This strategy is usually employed when a pair of stocks are traded in a market-neutral manner, that is, irrespective of whether the market is trending upwards or downwards, the two open positions for each stock hedge against one another. The key challenges in pairs trading are to:
- Decide on a pair that will provide you with good opportunities for statistical arbitrage over time
- Decide on the entry and exit points
A correlation between two (or more) stocks, industries, indexes, or other financial instruments is the foundation of pairs trading. Finding strong correlations between financial instruments is one of the keys to pairs trading because it creates a base for further analysis.
Pairs trading is a strategy that typically uses statistics to find relationships, help determine the direction of the relationship, and then decide how to execute a trade based on the data.
The pairs trader will employ statistics, fundamentals, technical analysis, and even probabilities to gauge these relationships. The empirical data are then analyzed to uncover information that gives the trader a methodical and effective way to carry out profitable trades.
Swing trading strategies are the practice of taking positions on both sides of market movements. Swing traders profit from the market’s erratic movements as the price oscillates back and forth between overbought and oversold levels.
The term swing high refers to when the price reaches a high level and then starts declining. In the same way, a swing low occurs when the price reaches a low level and then starts moving upward.
The art of swing trading involves spotting these swing highs and lows and then entering a position. The objective is to spot a larger trend and capitalize on it. The interpretation of each swing’s length and duration is essential for successful swing trading because they establish crucial support levels.
Furthermore, swing traders should pay attention to markets experiencing high levels of supply or demand. While monitoring trades, traders also keep an eye on whether momentum is increasing or decreasing within each swing.
The Bottom Line
Trading strategies vary from person to person and no one approach works for everyone. Your level of motivation, trading style, appetite for risk, and other factors will all affect which strategy will work best for you. The most successful traders are flexible and can alter their trading approach in response to new opportunities.
Successful traders frequently keep track of their gains and losses, which enables them to trade consistently and systematically.
Learning to trade successfully requires patience, and you will inevitably make mistakes and lose money while honing your skills. It is important to have the right knowledge and skills which can be achieved through an Algorithmic Trading course. EPAT® is the Executive Programme in Algorithmic Trading that facilitates your learning process. For beginners and advanced traders alike, the EPAT covers a variety of trading concepts, techniques, and strategies. Become a member today!