There has been a bit of talk lately about all the algorithmic trading that goes on in the stock markets. The latest statistic I saw was that about 70% of the trading activity in a given day is done through algorithmic trading.

Algorithmic trading is the process of using computers programmed to follow a defined set of instructions (an algorithm) for placing a trade to generate profits at a speed and frequency that is impossible for a human trader. The defined set of instructions are based on timing, price, quantity or any mathematical model. Algorithmic trading makes markets more liquid and makes trading more systematic by ruling out the human emotion’s aspect.

A very simple example of an algorithm might be to have the computer buy a stock when its 50-day moving average price breaks above its 200-day moving average price. When that event occurs, bang! the trade happens. No discussion, no wait and see. It’s done.

Getting into algorithmic trading has a pretty steep up-front cost. The investment in technology (hardware and software) is high and then you either must have your own programming skills or hire someone to write the algorithmic program.

A major disadvantage of algo-trading is the total dependence on technology. You need to be certain that your programs actually work the way they were written to work, and your computer/server needs to be working when the algorithmic event occurs.

Most people doing algo-trading keep their algorithms secret because if everybody is using it, then its effectiveness drops. Also, the successful algorithms work well for a time but over the long-term others begin to mimic them and again their effectiveness goes down.

Being 60-something, I must admit to being partial to the human factor, emotions, and being all involved in the buying and selling decisions of one’s investments. I tend to believe that algo-trading is a part of the increase in volatility that we see in the markets. As these algorithms are hit, massive amounts of shares are traded, so it must affect the prices dramatically.

For better or worse, algorithmic trading is here to stay and will likely increase as technology advances.

These are the opinions of Mike Berry and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice.

Mike Berry is a Registered Representative offering securities through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Legacy Wealth Management, LLC and Cambridge are not affiliated. Cambridge does not offer tax advice.

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