In order to understand what algorithms are, let’s take a brief look at what investments are and why individuals, companies, and countries invest.
A placement of capital or allocation of money in expectation of deriving or benefiting income or profit from its use of appreciation. Investments make us profits and not losses. The return may consist of a gain (or loss) realized from the sale of a property or an investment, unrealized capital appreciation (or depreciation), or investment income such as dividends, interest, rental income, etc., or a combination of capital gain and income. Some individuals, companies, and countries prefer investments to divestments because they are more profitable in the long run.
So if you don’t want to ‘throw your money’ into the wrong investments, you need algorithms for accurate stock market predictions.
Now, you may be wondering what algorithms are and what they have to do with investments. Algorithms are just a detailed set of directions for solving a problem or achieving a task. A simple example of an algorithm is a cooking recipe that gives you detailed directions for preparing a meal. In finance, algorithms are used in loan pricing, stock trading, asset-liability management, etc. Before 2020, the overall trading volume in the US was generated through algorithmic trading.
Algorithmic trading was developed to make use of speed data processing advantages that computers have over human traders. This definitely makes it easier for investment banks and organizations to keep track of dividends without compromise. This is simply an automated trading system using high-speed computer programs. There are different strategies used in algorithmic trading also called ‘algo-trading’.
MEAN REVERSION STRATEGY
This is also an ‘Event-driven’ strategy that identifies investment opportunities by use of directional strategy market movements or inconsistencies to pick investments across a variety of markets. Investors acquire stock when the trade market is favorably low and sell off these stocks at an oversold price and assume the market has a risk-free asset with an interest rate
This strategy uses behavioral finance through the use of an efficient market hypothesis. Since prices reflect as much information as dictated by the combination of economic conditions and the number and nature of different groups of markets. This strategy exploits the relative price movement with the use of analytical financial instruments. This strategy is highly effective for investors because it quantitatively and efficiently makes accurate stock market predictions which in turn favors the investor.
GLOBAL MACRO STRATEGY
The analysis and predictions of global macro strategies that invest on a large scale around the world based on these predictions and geopolitical developments including government policies and inter-government relations. This involves monitoring interest rate trends, business cycles, a global network of the flow of funds, global imbalance patterns, and changing growth models of emerging economies. Investors make use of some global predictions to decide when the stock market is favorable for buying stocks and when to sell off those stocks.
BENEFITS OF ALGORITHM
- Reduces the cost of a transaction.
- Simultaneous automated checks on multiple market conditions.
- Reduce the possibility of mistakes by human traders based on emotional and psychological factors.
- Trade order placement is instant and accurate.
- With algorithms, trades are timed correctly and instantly to avoid significant price changes.
- It also helps to reduce the risks of manual errors when placing trades.
Although algorithmic trading is very beneficial and helps companies keep track of their trades, they also have their downsides;
- It has brought about developing completion among exchanges for the fastest processing times for completing trades.
- It has also caused a drastic shift in the types of employees working in the financial industry.
- There are now more automated markets in the world and more are still emerging.