Post written by Anshul Gupta. Follow me ontwitter.
Executive summary
The world has changed a lot in the last 10 years. Gone are the days when people used to trade on trading floors. Now it is the time of supercomputers, artificial intelligence programs that run on these machines, decision making in microseconds on millions of situations and money making without direct human interference. Big financial institutions have more people working on design of sophisticated trading algorithms than on the trading floor. This paper is intended to look into the peculiarity of automated trading and how it impacts the market. Since nothing is hidden in the market, an attempt has been made by us to understand it on the eve of a recovering global economy. The paper ends with a few suggestions to policy makers to make the practice healthier for the economy as a whole.
Automated Trading - The Concept
“Algo” trading, used often as a catchphrase for any or all of the following: black-box trading, high-frequency trading or robo trading, is the use of computer programs for entering trading orders with the computer algorithm deciding on aspects of the order such as the timing, price, or quantity of the order, or in many cases initiating the order without human intervention. There is nothing new in using all publically available information to help you trade; what’s novel is the quantity of data available, the lighting speed at which it is analyzed and the short time that positions are held.
Over the past several years Financial Institutions have devoted substantial resources towards developing and maintaining a computer platform1, which allows the Financial Institutions to engage in sophisticated, high speed, and high-volume trading on various stock and commodities markets. The trades made through the platform typically generate many millions of dollars of profits per year for the Financial Institutions.
Sometimes people have say that, how can a system that is computerized and requires no human intrusion, perform at any consistent rate? But that's exactly why it does, since it has no human emotion to contend with. The more humans get involved in trades, the more likely it is for mistakes to ensue. Now there are many traders, who are superb at intuition, and the vast majority of trades happen on "gut feel" - so there is always the sentiment of a loss of control when you let it all happen in an automated way. But you can't back-test "gut feel" and you can't establish how something might have worked in the past when it's based on intuition.
(Taken From My Article submitted to Money manager; a magazine, jointly published by IIM A, B and C)