What is algorithmic trading?
Algorithmic trading, also known as a program or automated trading, refers to using computer algorithms to place trades automatically.
Algorithms are sets of rules used to determine when and how to trade. They can execute orders based on a predetermined strategy or automatically adjust orders in response to market conditions.
Why use algorithmic trading?
Several reasons exist why investors might choose to use algorithmic trading strategies:
1. To minimise costs – Automated trading can help traders avoid costly mistakes by placing orders quickly and efficiently. It can also help them take advantage of price discrepancies between different markets and exchanges.
2. To minimise risk – Algorithmic trading can help traders limit their exposure to risk by automatically adjusting their orders in response to market conditions.
3. To improve returns – Algorithmic trading can help traders maximise their profits by automatically executing trades based on predetermined rules.
How does algorithmic trading work?
There are three main algorithmic trading strategies: discretionary, arbitrage and hedging.
1. Discretionary algorithms are used by human traders who decide when and how to trade. They rely on news, analysis, and intuition to decide which stocks to trade and when to trade them.
2. Arbitrage algorithms exploit price discrepancies between different markets. For example, a trader might buy stock in one market and sell it immediately in another market for a higher price. This strategy relies on the belief that the prices of stocks will eventually converge.
3. Hedging algorithms are used to minimise risk by automatically adjusting orders in response to market conditions. For example, a hedging algorithm might sell a stock if the price begins to fall below a certain threshold.
How is algorithmic trading regulated in Hong Kong?
Algorithmic trading is regulated in Hong Kong by the Securities and Futures Commission (SFC). The SFC has put rules governing how algorithmic trading can be used and specifying the responsibilities of brokers and traders who use algorithmic trading strategies.
Benefits of using algorithmic trading in Hong Kong?
Algorithmic trading has several benefits in Hong Kong, including:
1. Reduced costs – Automated trading can help traders save money by minimising trading costs.
2. Reduced risk – Algorithmic trading can help traders limit their risk exposure by automatically adjusting orders in response to market conditions.
3. Increased efficiency – Algorithmic trading can help traders place orders quickly and efficiently, allowing them to take the lead on price discrepancies between various markets and exchanges.
4. Increased returns – Algorithmic trading can help traders maximise their profits by automatically executing trades based on predetermined rules.
5. Increased liquidity – Algorithmic trading can help increase liquidity in the market by automatically placing orders when there is a shortage of buyers or sellers.
6. Faster execution – Automated trading can help traders execute orders quickly and efficiently, allowing them to take advantage of price movements.
7. Greater transparency – Using automated trading strategies, investors can ensure that their trades are executed transparently and fairly.
Risks of algorithmic trading in Hong Kong?
While algorithmic trading has several benefits, it also carries some risks that investors should be aware of:
Unpredictable market conditions are inherently unpredictable, and even the best algorithms cannot always account for unexpected events.
Over-reliance on technology – Algorithmic trading can lead to traders becoming over-reliant on technology, leading to disastrous results if the technology fails.
Copycat behaviour – Algorithmic trading can lead to copycat behaviour as traders attempt to mimic the strategies of others. It can lead to market volatility and instability.
Increased vulnerability to hacking – Algorithmic trading systems are vulnerable to hacking, resulting in significant losses for investors.
Manipulation – Algorithmic trading can be manipulated by malicious actors who use automated strategies to exploit market vulnerabilities.
How is algorithmic trading used in Hong Kong?
Algorithmic trading is used in several ways in Hong Kong, including:
1. To place orders automatically in response to price movements.
2. To take advantage of price discrepancies between different markets and exchanges.
3. To hedge against risk by automatically adjusting orders in response to market conditions.
4. To maximise profits by automatically executing trades based on predetermined rules.
5. To increase liquidity in the market by automatically placing orders when there is a shortage of buyers or sellers.
6. To execute orders quickly and efficiently, allowing traders to take advantage of price movements.
Link to Saxo Hong Kong for more information.