Algorithms have become an essential component of daily life across all industries. They are behind the scenes in many decisions. To define it simply, an algorithm is a set of rules necessary to complete a task within a certain number of steps. Here, experienced investor Dan Calugar shares how algorithms are being used in the finance world today.
In the finance world, algorithms are used for many areas, including trading on the stock market, pricing of loans, and asset-liability management. Specifically, algorithmic trading involves using complex formulas combined with human oversight and mathematical models to determine potential outcomes better.
Companies use algorithms for trading in the stock market for many purposes. As the price of stocks, ETFs, bonds, and various commodities may register differently across multiple trading platforms, an algorithm can quickly comb through the data to register the desired output for a trade. Many companies utilize this information when they must execute a large order on the stock market that is too complex for a human to compute manually.
Other institutions that commonly use algorithms in trading are investment banks, mutual funds, hedge funds, and pension funds. Many of these large institutions require changes in investments from time to time that involve offloading large amounts of a specific investment that could impact the overall market.
In trading, some of these algorithms are called Percentage of Volume, Volume Weight Average Price (VWAP), Time Weighted Average Price (TWAP), Pegged, Implementation Shortfall, and Target Close. Each of these algorithms uses a specific set of pre-set instructions that take into account the time, price, or volume of the market and subsequently sends a portion of the overall trade to the market over a period of time. These methods were designed so that decision-makers and traders could eliminate the stress of watching the market all day. While many people commonly misconstrue algorithmic trading as a way for investors to get ahead and make a quick profit, in reality, many algorithms implemented for trading are designed to help reduce overall cost, adverse market impacts, and risks involved in executing a trade.
There is another facet of algorithmic trading, which is sometimes called automated trading and black-box trading. These strategies can be geared more towards individual investors who wish to take any human error or opinion out of their trading strategies. Individual investors can determine specific goals, whether they are bullish or bearish – whether they are optimistic or pessimistic on market outlook – and build an algorithm to trade based upon pre-set goals. While algorithms can certainly give investors a more hands-off approach, there are still risks associated with trading.
About Daniel Calugar
Daniel Calugar is a versatile and experienced investor with a background in computer science, business, and law. He developed a passion for investing while working as a pension lawyer and leveraged his technical capabilities to write computer programs that helped him identify more profitable investment strategies. When Dan Calugar is not working, he enjoys spending time working out and being with friends and family and volunteering with Angel Flight.