Adoption of automated execution Source: Aite

Group, 2010

Reasons for using robot trading

Source: The TRADE Annual Algorithmic Survey

Technological change has revolutionized the way nancial assets are traded. Every step of the trading process, from order entry to trading venue to back oce, is now highly automated, dramatically reducing the costs incurred by intermediaries. By reducing the frictions and costs of trading, technology has the potential to enable more efficient risk sharing, facilitate hedging, improve liquidity, and make prices more efficient. This could ultimately reduce the cost of capital for rms. There are many dierent algorithms, used by many dierent types of market participants. Some hedge funds and broker-dealers supply liquidity using algorithms, competing with designated market-makers and other liquidity suppliers. For assets that trade on multiple venues, liquidity demanders often use smart order routers to determine where to send an order (e.g., Foucault and Menkveld (2008)). Statistical arbitrage funds use computers to quickly process large amounts of information contained in the order ow and price moves in various securities, trading at high frequency based on patterns in the data. Last but not least, algorithms are used by institutional investors to trade large quantities of stock gradually over time. Nowadays every large broker-dealer oers a suite of robots to its institutional customers to help them execute orders in a single stock, in pairs of stocks, or in baskets of stocks. Robots typically determine the timing, price, quantity, and routing of orders, dynamically monitoring market conditions across dierent securities and trading venues, reducing market impact by optimally and sometimes randomly breaking large orders into smaller pieces, and closely tracking benchmarks such as the volume-weighted average price (VWAP) over the execution interval. As they pursue a desired position, these algorithms often use a mix of active and passive strategies, employing both limit orders and marketable orders. Thus, at times they function as liquidity demanders, and at times they supply liquidity. The declining costs of technology have led to its widespread adoption throughout nancial industries. The resulting technological change has revolutionized nancial markets and the way nancial assets are traded. Many institutions now trade via algorithms, and we study whether algorithmic trading at the NYSE improves liquidity. Our results suggest that algorithmic trading lowers the costs of trading and increases the informativeness of quotes. Surprisingly, the revenues to liquidity suppliers also increase with algorithmic trading, though this eect appears to be temporary. We have not studied it here, but it seems likely that algorithmic trading can also improve linkages between markets, generating positive spillover eects in these other markets. Finally, our results have important implications for both regulators and designers of trading platforms. For example, the U.S. Securities and Exchange Commissions Regulation NMS (SEC (2005)) is designed to increase competition among liquidity suppliers. Our results highlight the importance of algorithmic liquidity suppliers and the benets of ensuring vigorous competition between them.

Robot trading systems, also referred to as mechanical trading systems, algorithmic trading, automated trading or system trading, allow traders to establish specific rules for both trade entries and exits that, once programmed, can be automatically executed via a computer. The trade entry and exit rules can be based on simple conditions such as a moving average crossover, or can be complicated strategies that require a comprehensive understanding of the programming language specific to the user's trading platform, or the expertise of a qualified programmer. Automated trading systems typically require the use of software that is linked to a direct access broker, and any specific rules must be written in that platform's proprietary language.

Advantages of Automated Trading Systems There is a long list of advantages to having a computer monitor the markets for trading opportunities and execute the trades, including:

Minimize Emotions. Automated trading systems minimize emotions throughout the trading process. By keeping emotions in check, traders typically have an easier time sticking to the plan. Since trade orders are executed automatically once the trade rules have been met, traders will not be able to hesitate or question the trade. In addition to helping traders who are afraid to "pull the trigger", automated trading can curb those who are apt to overtrade buying and selling at every perceived opportunity. Ability to Backtest. Backtesting applies trading rules to historical market data to determine the viability of the idea. When designing a system for automated trading, all rules need to be absolute, with no room for interpretation (the computer cannot make guesses it has to be told exactly what to do). Traders can take these precise sets of rules and test them on historical data before risking money in live trading. Careful backtesting allows traders to evaluate and fine-tune a trading idea, and to determine the system's expectancy the average amount that a trader can expect to win (or lose) per unit of risk.
Preserve Discipline. Because the trade rules are established and trade execution is performed automatically, discipline is preserved even in volatile markets. Discipline is often lost due to emotional factors such as fear of taking a loss, or the desire to eke out a little more profit from a trade. Automated trading helps ensure that discipline is maintained because the trading plan will be followed exactly.

Achieve Consistency. One of the biggest challenges in trading is to plan the trade and trade the plan. Even if a trading plan has the potential to be profitable, traders who ignore the rules are altering any expectancy the system would have had. There is no such thing as a trading plan that wins 100% of the time losses are a part of the game.

Improved Order Entry Speed. Since computers respond immediately to changing market conditions, automated systems are able to generate orders as soon as trade criteria are met. Getting in or out of a trade a few seconds earlier can make a big difference in the trade's outcome. As soon as a position is entered, all other orders are automatically generated, including protective stop losses and profit targets. Markets can move quickly, and it is demoralizing to have a trade reach the profit target or blow past a stop loss level before the orders can even be entered.
Disadvantages and Realities of Automated Trading Systems Automated trading systems boast many advantages, but there are some downfalls of and realties to which traders should be aware.

Mechanical failures.

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