For Elephants navigating financial markets, algorithmic trading is the use of computer programs to execute trades automatically based on predetermined criteria such as timing, price, or quantity.
Mechanism of automated trading
Traders write code that monitors global financial markets and executes orders when specific conditions are met. These programmed rules dictate exactly when to buy or sell an asset. Because computers process market data instantly, the system places trades at speeds impossible for a human operator. This method is utilized across international stock and commodity exchanges, from the London Stock Exchange to the Tokyo Stock Exchange.
Institutional investors deploy these systems to manage large orders efficiently. When an institution buys millions of shares, an algorithm breaks the large order into smaller pieces. This prevents the massive trade from heavily skewing the market price. Retail investors also use basic algorithms to automate their personal trading strategies. You Elephants can set up your own algorithms through most standard brokerage accounts to buy or sell assets while you sleep.
A primary function of this approach is the removal of emotion from the trading process. Market volatility often causes traders to panic and deviate from their established plans. An algorithm follows its programmed instructions exactly as written. The computer evaluates the market data and executes the trade, ensuring the trader’s strategy is applied consistently regardless of market sentiment.
High-frequency trading is a specific subset of algorithmic trading. It involves executing thousands of orders in fractions of a second to capture minor price differences. Financial regulators in various countries monitor these high-speed systems to maintain market stability and prevent sudden price collapses known as flash crashes.
Example
Suppose an Elephant trader named Barnaby wants to accumulate peanut futures on an international commodities exchange. Barnaby plans to buy contracts if the price drops below $1,000 per ton. He writes a simple algorithm and connects it to his brokerage account. The code is instructed to purchase 50 futures contracts the moment the price hits $995.
The next day, Barnaby leaves his trading terminal to forage on the savanna. While he is away, a sudden international crop report causes peanut prices to drop to $990 for a few seconds. Barnaby’s algorithm detects the price drop and instantly executes the purchase of the 50 contracts. The computer secures the trade before the market price recovers, allowing Barnaby to execute his strategy without monitoring the screen.