Over the past decades, the capital market has seen huge improvements with technology. Technological evolutions have played a more crucial role in the growth of Stock markets. Algorithmic trading is one such development utilized for automated trade execution on stock exchanges in the screen-based trading system.
One of the trading styles is intraday trading, which has evolved with technological advancements, like algorithmic (algo) trading strategies. There are increased intraday trading volumes with Algo trading. It is found that securities with higher algorithmic trading resulted in lower liquidity costs and volatility. Also, higher algo trading leads to lower intraday liquidity risk and a lower incidence of intense intraday price movements.
Let us learn more about intraday trading and its results with algo trading.
Intraday Trading
Intraday trading has emerged with advanced technologies. It involves the trades where the traders have to enter and exit from their positions in the stock market within the same trading session. Therefore, intraday trading essentially requires stocks with high liquidity. This trading style is aimed at quick profits. The trader can enter or exit the trade within a few seconds, minutes to hours, to days.
Intraday trading is based on small price movements that can favour the traders significantly. This trading style can give an advantage in the equity segment, equity derivatives, currency derivatives, commodity Futures & Options, etc.
The demat account cannot be avoided when it comes to online trading as it is necessary to take delivery of the stocks. But demat accounts are not the concern of day traders. They just need a trading account.
What is Algorithmic Trading?
Algorithmic trading refers to executing trade orders utilising pre-programmed trading instructions for price, timing and volume of trade primarily. Algo trading bots based on a highly scalable model can work on multiple levels of automatic trade. Algo trading is especially beneficial for large orders.
Algorithmic trading is based on complex formulas, mathematical models, and human supervision to make buying or selling decisions of financial securities. An algorithm consists of directions to solve a problem.
Day traders often use algorithmic or high-frequency trading (HFT) that can make thousands of trades per second. Algorithmic trading can be used in order execution, arbitrage, and trend trading strategies.
Algorithm Trading and Market Quality
Algorithm trading impacts various dimensions of market quality – mainly liquidity, volatility and efficiency. Following is the impact of algo trading on market quality:
- Liquidity: Algo trading either has a positive impact on liquidity or no impact at all. Higher algorithm trading intensity increases liquidity. Typically market makers use algorithmic trades to create liquidity.
- Volatility: With high algo trading intensity, volatility could increase because some traders prefer high volatility as a market-making strategy and enter the market during high volatility. High volatility attracts additional liquidity. It should be noted that the same traders generating higher volatility can also lead to lower liquidity if they withdraw.
- Efficiency: Algo trading leads to higher price efficiency. There are lower execution costs when algo trading intensity is higher. Higher algo trading intensity indicates higher price efficiency and lower transaction cost, which ultimately increases intraday returns.
Thus, you should note that algo trading can have both positive and negative effects. For Positive contribution, it transmits information more rapidly into market prices and improves market liquidity. For Negative contribution, it increases adverse selection costs for non-algorithmic traders, which can result in negative externalities. Experienced traders are able to manage high-frequency trades which is a subset of Algo trading.
Algorithmic trading is considered helpful to active traders for the best trade execution. It makes it near impossible to miss a trading opportunity available for a short span in the market and helps traders to book profits quickly from small price fluctuations. Traders involved in scalping trades commonly employ algorithms because of the need for rapid buying and selling of securities at a small price increase.
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