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Algo Trading

Gourav Goyel
Agenda
• History of Computerized Trading
• The Efficient Market Hypothesis
• Algorithmic vs Automated vs High Frequency Trading
• Introduction to Technical Analysis
• Terminologies
• Types of trading strategies
• Introduction to Candlesticks
• Introduction to Chart Patterns
• Developing a Trading Strategy
History of Computerized Trading
• Introduced by the New York Stock Exchange in 1970
• Designated Order Turnaround (DOT, and later SuperDOT) system: It is used as system which routed orders electronically to the proper trading desk to be
executed manually
• Opening Automated Reporting System (OARS) system: It aided the specialist in determining the market clearing opening price.
• Program trading was blamed first time in 1987 for sudden stock market crash.
• In 1990s, program trading permitted smaller differences between the bid and offer prices, decreasing the market-makers' trading advantage, thus
decreasing market liquidity.
• This decreased market liquidity led to institutional traders splitting up orders according to computer algorithms in order to execute their orders at a better
average price; and thus increased the use of program trading.
The Efficient Market Hypothesis
• Whether the market is efficient
• Means whether it reflects all the information made available to market participants at any given time
• Assumptions of EMH:
• all investors perceive all available information in precisely the same manner
• no single investor is ever able to attain greater profitability than another with the same amount of invested funds
• no investor should ever be able to beat the market

• But
• it takes time for stock prices to respond to new information released into the investment community
Algorithmic vs Automated vs High Frequency Trading
• Algorithm
• Algorithm is a set of rules for accomplishing a task in a certain number of steps.

• Algorithmic Trading
• Algorithmic trading refers to trade execution strategies that are typically used by fund managers to buy or sell large amounts of assets.
• They aim to minimize the cost of these transactions under certain risk and timing constraints i.e. to minimize the impact of trading by slicing orders.

• Automated Trading
• Automated trading, often confused with algorithmic trading, is the complete automation of the quantitative trading process.
• Automated trading use quantitative modelling and indicator tracking to determine when to enter and exit a trade.
• This type of trading tends to be done by quantitative hedge funds that use propriety execution algorithms and trade via DMA or sponsored access.

• High Frequency Trading


• High-frequency trading (HFT) is a subset of automated trading.
• Here, opportunities are sought and taken advantage of on very small timescales from milliseconds up to hours.
• It generally depends upon trend analysis, time series analysis, machine learning and artificial intelligence
• Its role is for market making, providing liquidity, taking advantage of any price discrepancies
Introduction to Technical Analysis
• What: research of market dynamics
• How: done mainly with the help of charts & historic price movement
• Why: To forecast future price development
• Three Axioms for Technical Analysis
• Market movement considers everything
• The prices move with the trend
• The history repeats itself
Terminologies
• Support
• Support is a level at which bulls (i.e., buyers) take control over the prices and prevent them from falling lower
• Resistance
• Resistance is the point at which sellers (bears) take control of prices and prevent them from rising higher
• Trade Price
• At which a bull and bear agree to do business
• Supply
• The number of shares that sellers are willing to supply at a given price
• Demand
• The number of shares that buyers are willing to buy at a given price
• traders’ remorse
• If the prices will return to a support/resistance level following a price breakout
Types of trading strategies
• Arbitrage
• Arbitrage is the simultaneous purchase and sale of an asset to profit from a difference in the price
• Causality
• The movement of one stock/exchange determines the movement of other stock/exchange

• Mean Reversion
• It is a theory suggesting that prices and returns eventually move back towards the mean or average

• Trend Following
• The philosophy of trend following trading is to buy stocks that are in an uptrend and sell them when the trend finishes
Introduction to Candlesticks
• The Japanese began using technical analysis to trade rice in the 17th-18th century
• The US version initiated by Charles Dow around 1900
• Price Action:
• Price action is the movement of a security's price
• It attempts to find order in the sometimes seemingly random movement of price; using technical and chart pattern analysis
• The candlestick and price bar are one of the most important method of technical and chart pattern analysis

• The guideline principals of Price Action:


• The “what” (price action) is more important than the “why” (news, earnings, and so on).
• All known information is reflected in the price.
• Buyers and sellers move markets based on expectations and emotions (fear and greed).
• Markets fluctuate.
• The actual price may not reflect the underlying value
Candlestick Pattern

1: Bulls’ control
2: Bears’ control
3: Neither - neutral
4: Bears’ control
5: Bulls’ control
6: Neither - neutral

Candlesticks do not reflect the sequence of events between the open and close, only the relationship between
the open and the close. The high and the low are obvious and indisputable, but candlesticks (and bar charts)
cannot tell us which came first.
Candlestick Pattern contd…

• Doji: Reversal pattern


• Engulfing: Reversal pattern
• Harami ("pregnant" in Japanese): Reversal pattern
• Kicker: Reversal pattern
• Dark Cloud Cover: Bearish reversal pattern
• Piercing: Bullish reversal pattern
• Shooting Star: Bearish reversal pattern
• Hammer: Bullish reversal pattern
• Hanging Man: Bearish reversal pattern
• Morning Star: Bullish reversal pattern
• Evening Star: Bearish reversal pattern
Introduction to Chart Patterns
Developing a Trading Strategy