Last Updated on 14 October, 2021 by Samuelsson
Algorithmic trading is becoming increasingly popular because the prospect of having a computer efficiently execute trades on behalf of a trader is an enticing one. This trading approach is used by many big trading firms, and many retail traders have started using it as well. It’s only proper to want to know if algorithmic trading is hard if you intend to soon adopt the approach.
Yes, algorithmic trading is hard, just like any other trading approach, and you need to put in lots of hours. You should know that trading, as it is presented in mainstream media sites, is quite deceptive. Mastering algorithmic trading requires a lot of hard work.
In this post, we will cover the following:
- What algorithmic trading is
- How it works
- Whether it is worth your effort
- What you need if you wish to adopt an algorithmic trading approach
- How to build an algorithmic trading system
What is algorithmic trading?
Algorithmic trading is a trading approach in which computer algorithms search the markets for trade setups and executes and manages trades for you. In essence, you provide the computer with trading algorithms that are coded with the rules to know when to enter a trade, the right position size, the direction to trade, and when to exit.
These algorithms will then execute the trades for you according to the specified rules. The algorithms are often coded based on specific trading strategies that have been shown to have trading edges in the markets. While there are different trading strategies with varying degrees of complexity, the ones that consist of the simplest conditions tend to work the best.
A trading strategy can be based on any trading idea. For example, a strategy could be to buy once the market makes a 7-day low, and sell once it makes a 7-day high. It could also be indicator dependent, where a certain behavior of the indicator generates a buy or a sell signal. For instance, a 2-period RSI going below 10 could signal a buy, while a rise above 60 could signal a sell. The trading strategy is the core of every algorithmic trader’s business because it is the buying and selling criteria of the strategy that are coded as the computer commands that constitute the trading algorithm.
Basically, algorithmic trading is automated, so algorithmic traders can run multiple trading algorithms based on different strategies at the same time, trading in many different markets and timeframes. This diversification of strategies, markets, and timeframes enables risk spreading — a feat that is hard to accomplish for typical discretionary traders, as they will find it difficult to handle more than a few strategies at a time.
How does algorithmic trading work?
Algorithmic trading works by giving your computer a trade instruction, and it monitors the markets and executes the instructions when conditions are met. The trade instructions are based on any chosen trading strategy that has been proven to work in the past. The trade criteria of the strategy are written as computer codes to create a trading algorithm.
You run the algorithm on your computer, letting it monitor the markets for trade setups that match the trading instructions. When it encounters one, it executes the trade according to the preset parameters — position size and all the rest. But first, you will need to backtest the strategy to be sure it’s profitable in historical data and then employ robustness testing to know if the strategy can perform as well in a real-market environment. If everything ticks well, you can go ahead to run the algo in your normal live trading. If you can’t go through the process of developing your trading algorithm, you may buy from a trustworthy trading bot vendor. However, there are many false trading vendors on the web, so you have to be very vigilant.
To put it all together, in algorithmic trading, the computer runs your trading for you. But it is not that simple. There may be bugs in the codes, making the trading system to malfunction, or your computer power, internet connection, or trading platform may cause glitches. So, you need to monitor your algorithmic trading system from time to time.
Regarding the trading platforms for algorithmic trading, there are many different platforms to choose from, but at the Robust Trader, we mostly use TradeStation, Multicharts, or Amibroker. Beginners will find TradeStation and Multicharts very user-friendly as their coding language is easy to learn.
What makes algorithmic trading hard?
If you want to go about it on your own, algorithmic trading is hard to learn! There is so much contradictory information out there, making it almost impossible to know which one to take seriously, and the fact that much of the information can do more harm than good makes things a lot more difficult for an intending algorithmic trader.
Thus, the best thing you can do is to take a trading course because learning algorithmic trading by yourself is going to take years, but an investment in an algorithmic trading course will pay itself many times over. If you enroll in a good course, you could learn all the important things you need to create your very own algorithmic trading strategies in just a few months.
But it is not just about learning; finding a good trading strategy to use and developing your algo system requires a lot of work. You may have to spend a lot of time in front of the computer in search of new strategies. Financial journals may offer some trading ideas, which you have to rigorously test to see how well they perform.
Despite the difficulties, the process of developing a strategy can be really rewarding and exciting, especially if you already find trading interesting, since you learn new things about the markets and how they work. But if you do not find time to build enough strategies, you can always buy a trading strategy from a trusted vendor.
Whatever the case, nothing is perfect in trading, so there will be some glitches even after developing or getting some great strategies. Definitely, you must try to minimize mistakes and get the best out of your strategies, but just know that certain things may be out of your control. Issues may arise from your computer, power supply, internet connection, or trading platform.
As a beginner, it is very easy to get frustrated when things don’t go as you planned. It could be in the form of rejected orders or anything else. Whatever it is, just know that things will finally fall into place if you keep doing the right things and taking care of any issues that arise as they come. Getting frustrated and angry will never solve any problem. Changing your expectations by accepting the difficulties will save you from a lot of frustration and anger.
But do not get us wrong; automated trading works very well. What we are saying is that it can be very hard as there are many steps to be mastered, and that takes time. As with anything in life, the first period is the hardest to overcome — you’re starting from scratch with nothing or very little resources and experience.
While you want quick solutions, what you will find is that building a portfolio of different strategies to trade will take up to a few years. And even after that, issues still will arise from time to time because nothing is perfect. What hinders most prospective algo traders is their lack of patience and discipline. Algorithmic trading takes time to learn and maintain. The strategies you build will degrade over time, and you may have to build new ones to replace them.
Is algorithmic trading worth it?
Learning algorithmic trading can be very hard, as many steps have to be mastered, but it is not impossible. While the learning process is hard and laborious, it is definitely worth it. Actually, what hinders many intending algorithmic traders, like other forms of trading, is their lack of discipline and patience.
If you put in the effort needed and push yourself through the first months, you will realize it is not only something you can do but also fun. Down the line, you will be able to reap the rewards of your hard work. The feeling of trading an algorithmic trading strategy that you have developed yourself is truly amazing and will make you want to try out more.
Sure, the early period will be difficult and stressful, but if you manage to withstand the psychological pressure during this period, you will be able to reap the benefits later — both in terms of doing what you love and making profits that are not attainable anywhere else.
While different categories of algorithmic trading may seem hard, bear in mind that other forms of trading are hard too. So, if you love trading, your best bet is algo trading. There will be bumps along the road, but when you come to the stage where you have your first strategy, just know that you have, at least, found yourself a new hobby if not a full-time job.
What you need if you want to become an algorithmic trader
For us, algorithmic trading is simply the best way to trade, but it is not that easy. You don’t just become an algorithmic trader. There are some skills you must have to succeed in the journey — yes, it’s a journey, a hard and torturous one at that. Some of those skills you need include:
- Coding skills: You definitely need to know how to code if you are to develop your algorithms yourself. The programming language to learn depends on the trading platform you intend to use as different platforms use different languages. Tradestation, for example, uses a coding language called “Easylanguage”, which, as the name implies, is very easy. The coding language for Multicharts is called “powerlanguage” but is very similar to TradeStation’s Easylanguage.
- Research skills: You need research skills to be able to search and develop trading ideas, as well as analyzing the results when you backtest your strategies. It sounds like an easy skill to have, but it is not.
- Trading skills: Your trading experience matters. When you know how the financial markets work, you will be able to build your algo system in a way to reflect the realities of the markets. For example, your trading experience will show in your risk management parameters and capital allocation.
- Patience and discipline: Learning the ropes in algorithmic trading takes time. You need lots of patience and discipline not to give up along the line.
Building an algorithmic trading system
Developing your own algorithm trading system is as rewarding as it’s difficult. Not many people can do it. If you can’t do it, you can buy from a trustworthy trading algorithm vendor. But if you want to develop your own, these are the main steps involved:
- Finding good trade ideas: The first step is to search for trading ideas that have been shown to have some merit in the market. You can search the web for ideas; one of the best places is finance journals where academics publish their research work.
- Developing strategies: When you have a worthy trade idea, you need to turn it into a tradable strategy. You achieve this by modifying the idea and writing the criteria for the trade entry, exit, and other special trade management specifications. Do this for every trade idea you want to develop.
- Coding the algorithms: The next thing is to convert your trading strategies into computer algorithms that can execute the instructions. To achieve this, you must know how to code in the language of the trading platform you are using. Write the instructions that tell the computer how to identify a trade setup and what to do when the market behaves in a certain way.
- Testing your algorithms: After creating your algorithms, you have to test them on the historical price action to be sure that there are no bugs and, most importantly, that the strategy performs well. But you don’t just stop there: you have to test the system for robustness. Some of the methods you can use for robustness testing are In Sample And Out Of Sample Testing, Walk Forward Analysis, and Forward Testing.