How to Create Effective Trading Algorithms to Automate Your Trading – Introduction
We are in the age that old science fiction movies predicted for decades. Today, we have self-driving cars, electric vehicles have become beautiful and faster, and in the financial markets, algorithms are making decisions better than humans. It is an age of machine learning and artificial intelligence. In machine learning, machines can understand what humans are saying and in artificial intelligence, software and machine can make decisions.
In the financial industry, these days, hedge funds are focusing on quantitative and algorithmic trading. This is mostly because the funds that focus on traditional strategies like growth investing are not performing. In recent weeks, we have read about the tribulations of hedge fund managers like David Einhorn and Bill Ackman. At their prime, they were the leading managers, followed by thousands of wannabe investors. Today, they have lost their spark and are often the ridicule of many.
As a trader, adopting is a thing you need to do. By this, you need to adopt to change while maintaining your edge. For example, you need to start learning innovative ways you can apply technology in making decisions.
A good example about how algorithms are leading the markets is seen when an economic or financial data is released. In the first few seconds, the underlying asset moves up or down sharply. Then, the asset starts to move in the opposite direction. This is algorithms at work. Essentially, what happens is that the algorithms react before humans. For example, if it is a company releases positive earnings, the algorithms will take the price higher. As humans go through the accompanying document, the price tends to rebalance.
First, you need to have the basic understanding of the technical, fundamental, and sentimental analysis. By having a good understanding about this, you will be at a better position to create your programs. It is impossible to create these algorithms without having the knowledge on the three.
Next, you should do the best you can to learn about programming. The most ideal language you can learn here is Python. It is a complex language but one you can understand if you put your all into it. The language helps you incorporate mathematical formulas into your trading process. Since this is a long-term goal, you should take your time to learn and understand the process. Fortunately, there are multiple free methods you can use to learn about Python. You can use websites like EDX, Coursera, and Udacity.
After learning all this, you should now use your understanding of the markets to develop quality models. These are models will be based on the technical and fundamental analysis. As a beginner, the models will take time to create.
After creating the algorithms, you should test them for a few months. Applying the models without taking time to test them will be dangerous for you. This is because you want a model or algorithm that is responsive to various dimensions of the markets. For example, when two data pieces are released at the same time, you want a model that will be responsive in the most profitable way.
Remember that no automated trading algorithm is ever perfect. Even the models created by the best mathematicians are often wrong. Therefore, ensure that your models consider the risks associated with the financial asset.