Introduction to Algorithmic Trading

Disclaimer
This workshop is for educational purposes only and does not constitute an offer to
sell, a solicitation to buy, or a recommendation for any security; nor does it
constitute an offer to provide investment advisory or other services by the
speakers. Nothing contained herein constitutes investment advice or offers any
opinion with respect to the suitability of any security and any views expressed
herein should not be taken as advice to buy, sell, or hold any security or as an
endorsement of any security or company. The speakers are not responsible for the
losses incurred due to the buying and selling of securities.
Outline
● Overview of financial markets

● Electronic exchange

● Types of Trading Rationales

● Automated Trading

● DEMO Trading Strategy

● May 6, 2010 ?
History of Financial Markets

Amsterdam Stock Exchange Chicago Board of Trade New York Stock Exchange
17th Century 1980’s 21st Century

Source: moaf.org Source: Wall Street Journal Source: Yahoo Finance

Stock Exchange

● Buyers must find sellers and

sellers must find buyers.

● Buy side and sell side

● Brokers

● Market Makers
Trading Instruments

● Equities: Stocks, Equity Indices, IPOs

● Fixed Income: Fixed Deposit, Bonds, Credit products

● Commodity: Bullion, Crude Oil, Agri Commodity

● Property: Real estate, Mortgage (MBS)

● Derivatives: Futures, Options, Swaps, Forward Contracts

● Currencies: Forex, Crypto

● ETF’s, Mutual Funds

Market Participants

Buy Side Sell Side

● Retail Traders/ Investors

● Investment Banks
● Asset Managers, Hedge
● Broker-Dealers
Funds, Private Equity
● Insurance companies
● Proprietary Trading firms
● Market Makers
Outline
● Overview of financial markets

● Electronic exchange

● Types of Trading Rationales

● Automated Trading

● DEMO Trading Strategy

● May 6, 2010 ?
Electronic Exchange

● The first electronic exchange

was started on 1971.

● By 1992 electronic trading

accounted for 42% of the
trading volume in U.S.

● Faster execution

● Decimalization

● API trading
Working of a Electronic Exchange
Basic Order Types

Market Order Limit Order

● Gets executed at market price. ● Execution happens against the

ask or bid price.
● Price is not guaranteed due to
slippage and liquidity issues. ● Price is certainly guaranteed

● Execution is fast. ● Execution is slow. Partial fill

can happen or may not even
● Consume liquidity (taker). happen.

● Larger orders may significantly ● Usually provides liquidity

move the market. (maker).

● Larger orders can be executed

without affecting the market.
Outline
● Overview of financial markets

● Electronic exchange

● Types of Trading Rationales

● Automated Trading

● DEMO Trading Strategy

● May 6, 2010 ?
Discretionary vs Systematic

Discretionary Systematic

Source: Research Gate

Source: the balance
Systematic Trading
● Systematic Trading involves set of instruction and steps that is executed by an
algorithm.

● It can be backtested and risks can be quantified using historical data and quantitative
models.

● Avoid human cognitive biases and risk associated with human emotions.

● Complex strategies can be only executed using systematic trading as they are not
possible for humans. A good example is HFT strategies.

● Systematic Trading strategies can be fully automated to run without any human
intervention.
Algorithmic Trading
● Development of electronic trading platforms lead to automate execution, which
lowered the bar of algorithmic trading.

● Technologies like DMA (Direct Market Access) and FIX (Financial Information
eXchange) gave access to real-time information. This also increased the quality and
granularity of historical data.

● Lower latency and increased data granularity gave birth to a high speed version of
algorithmic trading know as High Frequency Trading or HFT.

● High Frequency Trading involves buying and selling securities in a very small duration
of time usually a HFT position lasts for less than a second. And this is repeated
multiple times during a normal trading session.

● High Frequency Trading can be only executed using a computer algorithm. Analyzing
the markets at nanosecond level and sending multiple orders in a fraction of second
is not possible manually.
Outline
● Overview of financial markets

● Electronic exchange

● Types of Trading Rationales

● Automated Trading

● DEMO Trading Strategy

● May 6, 2010 ?
Architecture of a Trading System
● Trading systems depends on data
for trade generation from the
trading strategy.

● The alpha model generates a the

trading signals which are
combined using a portfolio
construction model for optimal
risk profile.

● The orders of trades are sent to

brokers/exchange by the trade
execution model for optimal
execution.

● Order fill data is analysed by

during post-trade analysis.
Classification of Trading Strategies
Momentum Mean-reversion Market making

● Time series ● Statistical Arbitrage

● Cross-sectional ● Time series

● Pairs-trading

Source: River financials

Source: auquan
Risks with Automated Trading
● Extreme market events: Trading systems are designed for particular market regime and
condition, during extreme market conditions the algorithm may not be able to take decisions
and lead to adverse effects.

● Lack of Transparency: Automated trading system can get very complex and turns into a
black box.

● Bug in the algorithm: With increasing complexity the chances of having bugs in the system
increases and in turn increases the chance of catastrophe.
https://www.bbc.com/news/magazine-19214294
https://www.henricodolfing.com/2019/06/project-failure-case-study-knight-capital.html
Outline
● Overview of financial markets

● Electronic exchange

● Types of Trading Rationales

● Automated Trading

● DEMO Trading Strategy

● May 6, 2010 ?
Time-series Momentum
Notebook Link : https://bit.ly/3vLUHJo
May 6, 2010 ?
Flash Crash of 2010
More into Flash Crash
References
● Harris Larry, 2002. Trading and Exchanges: Market Microstructure for Practitioners.

● Barry Johnson, 2009. Algorithmic Trading and DMA: An Introduction to Direct Access Trading
Strategies

● Edward Leshik, Jane Cralle, 2011. An Introduction to Algorithmic Trading: Basic to Advanced
Strategies

● Álvaro Cartea, Sebastian Jaimungal, José Penalva, 2015. Algorithmic and High-Frequency
Trading

● Chan, 2013. Algorithmic Trading: Winning Strategies and Their Rationale.

● Chan, 2008. Quantitative Trading: How to Build Your Own Algorithmic Trading Business.
References
● Carver Robert, 2015. Systematic Trading: A unique new method for designing trading and investing
systems

● Moskowitz, Tobias J. and Moskowitz, Tobias J. and Ooi, Yao Hua and Pedersen, Lasse Heje, Time
Series Momentum (September 1, 2011). Chicago Booth Research Paper No. 12-21, Fama-Miller
Working Paper, Available at SSRN: https://ssrn.com/abstract=2089463 or
http://dx.doi.org/10.2139/ssrn.2089463

● Gatev, Evan and Goetzmann, William N. and Rouwenhorst, K. Geert, Pairs Trading: Performance of a
Relative Value Arbitrage Rule (February 2006). Yale ICF Working Paper No. 08-03, Available at
SSRN: https://ssrn.com/abstract=141615 or http://dx.doi.org/10.2139/ssrn.141615

● Jegadeesh and Titman. Journal of Finance 2001. Profitability of Momentum Strategies:

An Evaluation of Alternative Explanations
QNA