In algorithmic trading (or “algotrading”) trades are performed automatically via a computer program. Trade decisions are performed by computer-based algorithms rather than by people.
Algorithmic trading is generally defined by much faster execution of purchases and sales than would be possible for human traders. That’s why many financial experts use the term “high frequency trading” as a synonym for this type of trading.
The criteria for trades to be defined as “algorithmic” encompass more than the mere purchases and sales of securities originated by a computer. Those processes are used by many online brokers and are widely available to private investors.
But to qualify as an algorithmic trader, a software service must be able to make trade decisions without human intervention.
However, people must be able to guide the software’s trade decisions, for example by setting limits to the prices and volumes of different securities categories in advance. With some programs, however, the algorithm makes autonomous decisions regarding volume, price and timing of trades.
Computer-based algorithmic trading is becoming increasingly important. It already accounts for more than half of all the transaction volume of some stock exchanges.
Algotrading is used primarily by major financial service providers like hedge funds in arbitrage strategies, while private investors largely miss out. Algorithmic trading has drawn an increasing amount of criticism in recent years, and stricter limits should lead to better regulation of high frequency trades in the near future.