In electronic financial markets, algorithmic trading, also known as algo, automated, black-box, or robo trading, is the use of computer programs for entering trading orders with the computer algorithm deciding on certain aspects of the order such as the timing, price, or even the final quantity of the order. It is widely used by pension funds, mutual funds, and other institutional traders to divide up a large trade into several smaller trades in order to avoid market impact costs and reduce other transaction costs.[1] It is also used by hedge funds and similar traders to make the decision to initiate orders based on information that is received electronically, before human traders are even aware of the information.
Algorithmic trading may be used in any investment strategy, including market-making, inter-market spreading, arbitrage, or pure speculation (including trend following). The investment decision and implementation may be augmented at any stage with algorithmic support or may operate completely automatically.
A third of all EU and US stock trades in 2006 were driven by automatic programs, or algorithms, according to Boston-based consulting firm Aite Group LLC. By 2010, that figure will reach 50 percent, according to Aite.[2]
In 2006 at the London Stock Exchange, over 40% of all orders were entered by algo traders, with 60% predicted for 2007. American markets and equity markets generally have a higher proportion of algo trades than other markets, and estimates for 2008 range as high as an 80% proportion in some markets. Foreign exchange markets also have active algo trading (about 25% of orders in 2006).[3] Futures and options markets are considered to be fairly easily integrated into algorithmic trading[4], with about 20% of options volume expected to be computer generated by 2010.[5] Bond markets are moving toward more access to algorithmic traders.[6]
