In this today’s world of cutting edge technology which are shaping financial markets are High Frequency Trading i.e. HFT. Have you ever wonder why in a fraction of second tons of volumes are generated.
One simple question comes in mind is, Who is responsible for it? The answer to this is Algorithmic Trading. Simply putting it is computer programs which are designed (after taking various scenarios in to consideration) to place order by machines.
This might come as a shock to many of you, but not all Algorithmic Trading is BAD. it’s just that different market participants use the technology differently. In order to keep it simple, and easy to understand, let us understand in detail, the GOOD and the BAD Algorithms.
What are GOOD Algorithms:
Institutional Investors use these Programs to Buy and Sell large blocks of shares of a given stock. So for example, if an Institutional Investor wants to sell 100,000 Shares of RELIANCE, instead of dumping the whole block on the open market and crashing the stock, the Institutional Investor uses a SELL Program, which breaks down this huge block of shares, into small lots of 100 shares. So 100,000 Share Block = 1000 Lots of 100 shares. Its easy and efficient, and more importantly, it doesn’t disrupt the market.
VWAP Programs are basically BUY/SELL programs, but instead of executing the orders at a user defined price range, these programs execute the orders as close to the VWAP as possible. This ensures the best execution price.
What are BAD Algorithms:
Market Maker Algos:
These are the parasites that manipulate stock prices and cause Flash Crashes. Market Maker Algos are on the lookout for Institutional BUY/SELL Programs, and once they detect one, they start manipulating the stock’s price in order to benefit form this huge order. Just like human market makers, but faster and more efficient.
Predator Algos are momentum ignition algos. They don’t give weight age to Technicals or Fundamentals. All they care about is the direction a stock is moving in, and they just jump on the bandwagon accelerating the move, either to the Upside or Downside.
It’s a shame that large institutions are dedicating majority of their resources to developing BAD Algorithms that can manipulate the market, and make sure that the big guys make money no matter what.
The cold truth and the bottom-line is “The House Always Wins”.