Every online platform or electronic/computer device uses an algorithm to perform different functions which include software and hardware-based routines. It is the pack of directions or instructions that helps resolve a problem or complete a task. An example of algorithm can be the step-by-step process of a dish, where the cook is given very concise steps to follow in order to create a perfect meal. In the same way, every online platform or electronic/computer device uses an algorithm to perform different functions which include software and hardware-based routines.
The finance world uses algorithms avidly due to the emphasis on the creation of HFT (High-frequency trading) and automated trading systems. This algorithm also helps in determining the prices of different financial tools like derivatives.
What is an algorithm?
The different fields where algorithms are utilized by financial organizations include asset-liability management, loan pricing, stock trading and other automated functions. For instance, in trading, the algorithm is usually used for determining quality, quantity, pricing or black-box trading. This trading uses computer programs to purchase and sell securities at a pace that is unfathomable by humans.
A big contribution by algorithms is using HFT (High-Frequency Trading). This includes the use of algorithms and trading. Although, due to the algorithms, the average holding period for stocks has fallen down from 4 years during the 1940s to a minute a decade ago.
Algorithms make life easy by cutting down on time for various tasks. This also accelerates the process through automation and saves money and time for companies. In trading, an algorithm helps to decrease the emotional deviations that often influence the investors’ decisions. Hence, they are used extensively by hedge investors, investment banks, etc. The various types of algorithms include market timing and arbitrage.
Use of algorithms in computer science
Algorithms are used extensively in computer science for the following reasons:
- Convert problems to mathematical expressions
- Process and create formulas
- Input the parameters for the outcome
- Execute the program
Different types of algorithmic trading
Trading algorithms help investors to make the right decisions for buying and selling on profits. For instance, a mean reversion helps to determine short-term pricing on the long-term average prices.
Arbitrage
Arbitrage means taking advantage of the differences in prices of the same asset but in different markets. Algorithms capitalize on the difference. They analyze the data and quickly act on the data by selling or executing a trade for profits.
Market Timing
This strategy utilizes backtesting to create hypothetical trades which creates an outline for trading. These strategies help to determine the future performance of an asset. They help the investor to find the best time for trading. It includes numerous datasets and testing.
Mean Reversion
Mean revision helps to reduce the time of calculating the average price of the stocks for a stipulated time period. If this time period exceeds the range of average price, based on standard deviations and previous indicators, the algorithm will execute trades accordingly. For instance, if the stock price falls below-average price, the trade will be beneficial based on the assumption that it will fall back to the mean.
