On the surface, algorithmic trading seems like the very definition of passive income. Imagine it. Entrusting your portfolio to a bespoke piece of software designed to buy and sell stocks based on algorithms that are designed to facilitate growth. It must be like having a tiny robot stockbroker in your pocket who never gets tired, never refuses to answer your call, never makes a human error and isn’t motivated by greed or self interest. WIth a tool like that in your pocket, you could sleep at night knowing that your investments are algorithmically primed for growth that will lead to lasting wealth.
Well, if it were that easy, everyone would be doing it. Algorithmic trading is a complex enterprise and while it involves the use of automated processes, that doesn’t mean that your algorithms generate money for you day in and day out while you kick back and sip your latte. Like any form of investment, it carries with it an element of risk and unless you give it the effort and attention that it deserves, you could find yourself losing everything. If you find yourself frustrated by an inability to make your portfolio grow sustainably, algorithmic trading may be able to give you the boost you need.
What’s wrong with normal trading?
Absolutely nothing, and if you have a good sense of the markets and a finger on the pulse, there’s no reason why you can’t continue to grow your money. Some, however, turn to algorithms for a number of reasons. Algorithms can scan the markets much faster than any human being and while they may be fallible they’re far less prone to error than human investors who may be motivated by irrational factors like instinct or a hunch. Even veteran traders will inevitably miss out on dozens of fecund investment opportunities even if they spend their day glued to the screen.
Algorithmic trading is open to anyone
Algorithmic trading is nothing new. It’s been used by hedge funds and investment banks in some form or other for decades, but it’s only relatively recently that a subculture of mathematicians, programmers, and entrepreneurs have begun to develop their own trading platforms in order to grow their investments beyond the limitations of regular trading.
What you need
So, by now your interest in algorithmic trading is likely piqued and you’re wondering what you need to get started. Well, the first thing you need is patience. While algorithmic trading strategies is fairly straightforward in principle (a robot does it), the enterprise is a very complicated one, and you can expect to spend a long while getting to know the process before you entrust your portfolio to it.
You may expect comprehensive coding knowledge is necessary and while it’s certainly advantageous it’s not necessarily essential. What you will need is significant time, money and resources to invest in buying or developing the coding infrastructure upon which to build your trading algorithms.
The first thing you need to do is understand the conditions that necessitate a purchase or a sale and this comes from parsing data from the markets. From a coding point of view your conditions provide the “ifs” to which your code provides the “then”. If a stock dips below a certain amount buy, if a stock tops a certain amount sell.
Your first step should be to create a flow chart of conditions and what how you would expect your algorithm to react to these conditions. Once you’ve done this, the next logical step would be to create a spreadsheet transposing the data from the spreadsheet as suggested here.
Build or buy
Once you have a working understanding of how a trading algorithm would work, you need to make the decision whether to build or buy your own. Both require sizeable investment. While sole trading software like AlgoTerminal is traditionally intended for use by hedge funds and professional quants, individuals can purchase ready made trading platforms. Be advised, however, that they do not come cheap. Building your own algorithm requires extensive coding knowledge but it also affords you complete customization, allowing you to develop a platform that’s entirely tailored to your needs. If you are pretty code literate but don’t relish the idea of starting from scratch you can build on a free source like Quantopian.
A serious investment
Whichever option you choose, swimming in the waters of algorithmic trading requires a serious level of investment. Purchasing a ready made platform can be very expensive yet offer you quick market access while taking the time to build your own may prove a long drawn out affair. You can expect a serious investment in your time and resources… But one that may reap huge dividends.