ALGORITHMIC TRADING STRATEGIES
Any strategy for algorithmic trading requires an identified opportunity that is profitable in
terms of improved earnings or cost reduction. The following are common trading strategies
used in algo-trading:
General Strategies:
1. Trend-Following Strategies
The most common algorithmic trading strategies follow trends in moving averages, channel
breakouts, price level movements, and related technical indicators. These are the easiest and
simplest strategies to implement through algorithmic trading because these strategies do not
involve making any predictions or price forecasts. Trades are initiated based on the
occurrence of desirable trends, which are easy and straightforward to implement through
algorithms without getting into the complexity of predictive analysis. Using 50- and 200-day
moving averages is a popular trend-following strategy.
2. Arbitrage Opportunities
Buying a dual-listed stock at a lower price in one market and simultaneously selling it at a
higher price in another market offers the price differential as risk-free profit or arbitrage. The
same operation can be replicated for stocks vs. futures instruments as price differentials do
exist from time to time. Implementing an algorithm to identify such price differentials and
placing the orders efficiently allows profitable opportunities.
3. Index Fund Rebalancing
Index funds have defined periods of rebalancing to bring their holdings to par with their
respective benchmark indices. This creates profitable opportunities for algorithmic traders,
who capitalize on expected trades that offer 20 to 80 basis points profits depending on the
number of stocks in the index fund just before index fund rebalancing. Such trades are
initiated via algorithmic trading systems for timely execution and the best prices.
4. Mathematical Model-Based Strategies
Proven mathematical models, like the delta-neutral trading strategy, allow trading on a
combination of options and the underlying security. (Delta neutral is a portfolio strategy
consisting of multiple positions with offsetting positive and negative deltas—a ratio
comparing the change in the price of an asset, usually a marketable security, to the
corresponding change in the price of its derivative—so that the overall delta of the assets in
question totals zero.)
5. Trading Range (Mean Reversion)
Mean reversion strategy is based on the concept that the high and low prices of an asset are a
temporary phenomenon that revert to their mean value (average value) periodically.
Identifying and defining a price range and implementing an algorithm based on it allows
trades to be placed automatically when the price of an asset breaks in and out of its defined
range.
Strategies based on trading volume:
1. Volume-Weighted Average Price (VWAP)
Volume-weighted average price strategy breaks up a large order and releases dynamically
determined smaller chunks of the order to the market using stock-specific historical volume
profiles. The aim is to execute the order close to the volume-weighted average price (VWAP).
2. Time-Weighted Average Price (TWAP)
Time-weighted average price strategy breaks up a large order and releases dynamically
determined smaller chunks of the order to the market using evenly divided time slots between
a start and end time. The aim is to execute the order close to the average price between the
start and end times, thereby minimizing market impact.
3. Percentage of Volume (POV)
Until the trade order is fully filled, this algorithm continues sending partial orders according
to the defined participation ratio and according to the volume traded in the markets. The
related “steps strategy” sends orders at a user-defined percentage of market volumes and
increases or decreases this participation rate when the stock price reaches user -defined levels.
