Components of an Algorithmic Trading System
Posted On June 13, 2018
In our last blog post, we gave an Introduction to Algorithmic Trading in simple terms. Taking the next step forward, let’s talk about its core components:
- Trading Strategy/Algorithm
- Backtesting System
- Execution System
It is the logic behind buying and selling a stock. The time and price at which the algorithm system buys and sells a stock are of utmost importance in determining the amount of money one will make and is of a topmost priority to an algorithmic trader. Entering at a low and selling at a buy is the ideal scenario which most people who buy stocks look for. And to identify, such entry points is the entire game of trading.
Any trading strategy/algorithm is derived from an idea first. One needs to have a well thought of an idea of what he/she thinks is the best point to buy a position and to sell a position.
Example of an algorithm is:
Buy when the movement of the last 5 minutes of stock is upwards;
Sell when the movement of the last 5 minutes of stock is downwards;
A backtesting/simulation system is a computer program that tells you how good your idea is. It tells you how much money would have been made or lost if your idea had been traded in the live markets.
The algorithm is feed into the system and it starts trading with that algorithm with virtual cash on historical data. Trades are performed by the simulation system as if it’s real-time. To get a better understanding, let us suppose On 9th October 2017, you got a brilliant trading idea. But before live trading with it, you should test it on a virtual environment. That virtual environment is the simulation system, wherein you can also play with the variables on the virtual environment to test your idea in a robust manner.
So in a sense, it verifies the idea to some extent. It filters out the good and the bad and guides you through a strategy development process.
An execution system is the third pillar of Algorithmic Trading. It is the interface that connects your algorithm to the live markets and routes all your trades and signals given out by your algorithmic and places the actual order. At Kuants, a user doesn’t have to worry about the execution system. We have a robust and strong system that has been rigorously tested to place your orders in a seamless manner.
Each of these three components cannot survive without each other. If there is an algorithm but no execution system, it’s of no use. If there is an execution system but no algorithm, again of little help. And a “good” trading algorithm without a backtest is just one of the thousands of random ideas with no historical proof of performing well.