3 Common Strategies Used in Algorithmic Trading

Algorithmic trading uses computer programming software to make the trading faster and quicker making it profitable and efficient. Just as in manual trading, algorithmic trading also follows a strategy which can be customized by the user.

Here are the three common strategies in algo trading.

1. Trend- Following Strategy: This is a simple strategy that is based on observing market trends. Usually, the 50 day moving average and 200 day moving averages are used to make a decision on buying or selling a stock. For eg. If the 50-day moving average crosses the 200-day moving average, it is an indicator of a bullish trend indicating a buy. And conversely, if the 50-day moving average falls below the 200-day moving average, it is an indication for sell. Trades are executed based on desirable trends and don’t involve the complexities of predictive analysis. Trend following strategy tries to capitalise on the momentum in the market. It helps in identifying potential breakout or breakdown in asset prices. It helps in automation of trade, allowing quicker and efficient trading.

2. Arbitrage: An asset may be priced differently in different markets or exchanges. Buying at a lower price in one market and selling it at a higher price in a different market is known as arbitrage. Algo trading can be set up to capitalise on such opportunities caused by price differentials. The algorithm can be customized to follow arbitrage opportunities and benefit from them. There is another kind of arbitrage known as statistical arbitrage, which is aimed at taking advantage of price differences in a group of stocks and buying the undervalued stock while selling the overvalued stock.

3. Mean Reversion Strategy: This strategy tries to make gains based on the price fluctuations in the market. It is quite usual for prices to increase or decrease from time to time. But they usually revert to the mean in due course. If the asset price changes significantly from the average, the algorithm can execute buy or sell orders. If the price falls below the lower range, a buy order may be executed if there is a possibility of the asset bouncing back to its mean. When an asset price rises above the upper range, a sell order may be given as prices are likely to fall from that level.

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