13 Important Steps for Beginners Looking to Start with Algorithmic Trading (Algo trading)

In the stock market, algorithmic trading refers to trading that is automated by computers that are programmed to carry out specific orders under specified market conditions.  Algorithmic trading can be complex, so it helps to simplify the process as much as you can, especially if your end goal is to do high volume trading. The more you can automate the process, the better. You want to reduce your risk and maximize your potential for profit. This requires a lot of research and preparation. Algorithmic trading can be quite intimidating when you first start doing it, so it help to take it step-by-step and approach the process as a learning opportunity. Here are fourteen steps you should take if you want to begin algorithmic trading.

Step One: Find Helpful Resources

Start with research. When you want to take up a new activity, learning as much as you can about the subject matter will make the early stages a lot easier. There are several outstanding books that focus on algorithmic trading. Trading and Exchanges: Market Microstructure for Practitioners,  Algorithmic Trading: Winning Strategies and Their Rationale, and Algorithmic Trading and DMA: An Introduction to Direct Access Trading Strategies are great places to start.

These will give you the most comprehensive introductions into Algo trading, but if you are looking for the most current information on the subject, there are a number of blogs, podcasts, webinars, and videos you can find that will have more recent publication dates. An online training course would be particularly useful because you will receive hands-on experience you cannot receive from reading a book or blog. Talking to other people who do algorithmic trading for a living will also give you a lot of insights. Try to find two or three mentors who are willing to help you. They can help you navigate the intricacies of algorithmic trading and answer any questions that you might have.

Step Two: Have a Checklist of What You Need

You some basic equipment to start trading. You need a computer or a laptop. It will be easier if you have dual monitors, but one monitor will work in the beginning. The computer needs to have enough memory and processing speed. You do not necessarily need an expensive computer that has all the bells and whistles. You just do not want a computer that lags or crashed at random.

You will also need a reliable Internet connection. A cable or ADSL type of Internet connection works best for algorithmic trading. Speed will vary, but you generally do not want the lowest speed available from your provider. Opt for at least a mid-range option. If you end up not being happy with the Internet connection, you can always upgrade or downgrade later on, or change providers. Reliability is also crucial. If your connection goes out all the time, it will cause problems.

Finally, you will need a trading platform and a broker. There are a lot of options that you can choose from. Each platform/brokers tends to be geared toward a specific trading strategy. As a beginner, you do not yet have an established methodology. Thus, finding the perfect trading platform is likely not your top priority. You might want to try out several different platforms and see which one you like the best. Chances all you won’t know which one suits you best until you try it out. Many trading platforms offer trial periods, so you will not have to spend too much on experimentation.  As for brokers, you want to find one with a relatively low commission fee. Keep in mind that the one who has the lowest fee is not automatically the best, but you do not want a broker who has exorbitant fees.

Step Three: Index Fund Rebalancing

One of the most important things for beginners to understand about algorithmic trading is the importance of rebalancing. Rebalancing involves reallocating assets to a desirable makeup. Although the use of the word balance suggests a 50/50 allocation, it isn’t a requirement. Some people opt for a 30/70 or 40/60 allocation. You want an allocation that limits risk. The key to rebalancing is understanding the nature of different kinds of investments. For example, stocks tend to change with market conditions much more drastically than bonds.

Step Four: Pick the Right Trading Software

To succeed at trading, you need to have the right software. Having good software will ensure trade orders are carried out accurately, provide you will use analytical tools, increase the chance of profit, and take some of the stress out of trading.

When deciding on trading software, you want to look at how much market and company data the software has access to. You also want to consider how many different markets the software is compatible with. Latency, customizability, and backtesting features are also important things to consider. For the sake of simplicity, I am going to focus on MultiCharts. MultiCharts is a trading platform and software program that can be used for day trading and long-term investments. With this software, you will have access to many different HD charts, indicators, and trading strategies. The software also offers accurate backtesting and an array of other tools.

Step Five:  Install Platform

Once you decide on a software, install it. With MultiCharts you can opt for a 30-daily trial. During the trial period, the software is fully functional. All you need to input is your name and your email address. You will then receive a download link. If you do not receive the link, you might have a firewall or antivirus software that is blocking the link. Once the software is downloaded, you can either proceed as a trial or register for the real deal.

Step Six: Set up Profile

The next thing you want to do is set up a broker profile. MultiCharts supports a number of different brokerage services. Find one that you like and connect it to your account. Typically, you will need to enter login and password information and verify the server name, but the steps may be different depending on which broker profile you choose.

Step Seven: Set up Tools and Charts

Next, you want to set up analytical tools and predictive charts. To set up a chart, you add the necessary symbol from the data source. You can add manually or from the data vendor-supplied list. Go to the QuoteManager window. You should see an INSTRUMENT menu. Click ‘add symbol’ and then “data source’. Now select the tab that correlates to the type of symbol you want to add. A box should show up. Input the symbol name and press “lookup’. Now you can select and add the symbol you want.

Basically, each futures market has a corresponding ticker symbol. So it all depends on what and where you are trading. The MultiCharts website has a step-by-step guide on symbols, so if you choose that software, they will be able to walk you through the process.

There are a lot of tools you can choose from. You can find time-based charts, volume-based charts, price movement-based charts, and non-standard type charts. You can find tick, minute, and daily data.

Step Eight: Choose Strategies

There are many different strategies available for you to work with. One of the most basic strategies is Simple Moving Average, or SMA, which is a quantitative trading strategy. Other trading strategies include momentum and trend following, arbitrage, statistical arbitrage, and market making. These five strategies comprise the basics of algorithmic trading strategies. Each variety has advantages, so will likely want to use several different strategies in conjunction with each other for the most accurate results. Which strategies you choose will largely depend on current market conditions and what you are trading.

Step Nine: Follow Trends

No matter what strategies you use, trends are going to be important. You are going to want to follow moving averages, channel breakouts, price movements, and more. There are a number of indicators that can help your predict prices. You want to make sure you integrate trend following into your software so you have all of the data you need in a convenient place.

Step Nine: Keep It Simple

In the beginning, you do not want to overextend yourself. S&p 500, Nasdaq, bond futures, and blue-chip stocks might all interest you. Start with one and focus on becoming adept at earning money on the market. Once you feel more comfortable trading, you can start to explore other markets. If you try to to do too much too soon, you will end up bleeding money.

They key is to be realistic. The stories you hear in the media probably make trading sound easier than it actually is.  You are not going to hit it big right away. It takes time to learn the business of algorithmic trading and you will have to put it a lot of time and work if you want to succeed.

Step Ten: Get a Handle on Risk Management

Trading is by nature a risky business. You need to understand the risks involved in algorithmic trading so you are better prepared to overcome those risks. First, you need to figure out a money management system that works for you. Many experts suggest never risking more than 1% of your account balance on a single trade.  Say you have $30,000 in your account. The most you would want to risk is $300. This will enable you trade more regularly. If you want to last, you cannot have a strategy that leaves you broke by your first month. It is ultimately better to play it safe, especially early on when you are still learning the basics.

Risk also depends on position size. It is wise to learn how to calculate the appropriate position size for forex, stock, etc. early on. To manage risk properly, you need to factor in position size, entry price, and stop loss.

Set a daily loss limit. While it is important to limit individual trades, you also want to limit daily volume. You do not want to lose all of your funds you want to trade for a given month in a single day. While you might want to go all out, moderation is almost always preferable. A popular daily limit that many traders use is 3%. So for beginners, I would avoid risking more than 3% of your capital in a single day. If you reach your limit, do not push. Just stop for the day and pick back up the next day. If you have a decent strategy in place, you should not be hitting that daily limit very often. If you do find yourself hitting that limit frequently, you will want to rethink your strategy.

Step Eleven: Set up a Place Where You Can Keep a Record

Tracking your triumphs and pitfalls is an important part of the trading process. You want to have a spreadsheet where you can put thorough earning reports. If you keep meticulous records, you will be able to easily look back and see what you did right and what you did. You need to be able pinpoint gaps and setbacks so you can address them head on.

Step Twelve: Figure out Taxes

Depending on which jurisdiction you live in, the tax situation is going to be different. You want to know what to expect before you start trading. Different countries will define day trading in different terms. Some might consider it speculative. Some might consider it a substantial self-employed trading activity. Some might view it significant activities of a private investor. It should not be terribly difficult to find the tax codes for the jurisdiction you pay taxes in. The information should be readily available online. If you find the tax code confusing when you read, seek outside help.

In many cases, the jurisdiction will classify trading activity under multiple categories. You might fall under more than one category depending on your situation. The main thing to keep is that day trading activity fluctuates a lot, so things can change on a dime. You want to monitor you trades carefully to be safe. It would also be smart to receive advise from a tax expert. They can help you make sure you follow all laws and regulations to the tee.

Step Thirteen: Practice Decision Making

In the world of algorithmic training, you have to make a bunch of decisions on a daily basis. You need to learn to make rational decisions quickly without overthinking the little details. From what market to trade in to choosing a watch list, all of the decisions you make add up. Even choosing a good spreadsheet template is important. You do not want to think too much about the decisions you have to make, but you do not want to think too little either. Practice making smart decisions. Push back any instincts you might have to wallow in indecision. Trading is a fast-paced activity, so you cannot afford to waste time.

Summary

Once you have a strategy in place, you are ready to start trading and earning money. While algorithmic trading offers a lot of potential for profit, trading is risky activity by nature. Using automated software will give you an edge over people who trade manually and increase your chance for profit. You will be able to assess data faster and respond quicker to market fluctuations.

To really simplify the process, pick one market that interests you and meets your financial requirements and go from there. Try out some platforms and software and find one you like. The learn all you can about that software and how you can use it to automize your trading and improve your chance of earning a profit. Your focus early on should be learning the risks and figuring out ways to minimize those risks. Since the whole point is to make money, you do not want to end up losing money. Thus, risk management is extremely important. Once you settle on a strategy, focus on that one strategy for a good chunk of time. Become and expert in that strategy before you branch out. You want to have a winning strategy in place and if you try to navigate multiple strategies at once, you will just end up with multiple losing strategies.

Some trading platforms have a demo account. You can use this as training wheels. But once you do start trading in real capital, keep an in-depth record of your trades. Algorithmic trading can be quite a roller coaster ride. Information is power. Having detailed records can help make the ride a little smoother. Finally, do not be surprised if the first couple months are rocky. This should not dishearten you. Like most things, it take practice to become good at it. Most people have ups and downs at first. This is completely normal. You will become better with time.