Algorithmic Trading
The use of computer programs to execute trading orders automatically based on pre-set rules governing timing, price, quantity, or mathematical models.
What is Algorithmic Trading?
Algorithmic trading, or algo trading, uses computer programs to submit buy and sell orders to financial markets based on a defined set of rules without manual intervention. These rules can be simple — for example, buy when a stock's 50-day moving average crosses above its 200-day moving average — or highly complex, incorporating machine learning models trained on decades of market data. Algorithms can react to market events in milliseconds and manage large order flows with minimal market impact through techniques such as TWAP (time-weighted average price) and VWAP (volume-weighted average price) execution. Algorithmic trading is now dominant in equity markets, accounting for the majority of trading volume in US stocks, and is widely used by hedge funds, banks, and institutional asset managers.
Example
A large mutual fund needing to buy 2 million shares of Amazon without moving the price uses a VWAP algorithm that spreads purchases throughout the trading day in proportion to Amazon's historical hourly volume patterns. By mimicking the market's natural rhythm, the algorithm minimizes the average execution price impact compared to placing all 2 million shares as a single market order, which would likely spike the price immediately.