Algorithmic trading, is it ethical?

While algorithmic trading strategies have been increasing over recent years, 2024 is likely to see significant developments in this area with the adoption of and improvements in AI. This is a topic which attracts very different opinions and is often controversial. So, what is algorithmic trading, and is it ethical?

 

The premise of algorithmic trading

 

In simple terms, algorithmic trading uses computer programs that take particular actions based on specific rules. Surely, this is a similar fashion to traditional traders? Well, the speed and accuracy of algorithmic trading software make it stand out, analysing and executing transactions in a split second, well before humans have even recognised any change in the asset price.

 

The top five algorithmic trading strategies in 2023 will likely be replicated and even improved in 2024. These include:-

 

· Momentum trading

· Trend analysis

· Mean reversion

· Weighted average pricing

· Statistical arbitrage

 

While there are many attractions to algorithmic trading strategies, for many, the main attraction is the elimination of emotion. This characteristic has cost many traders a fortune in the past!

 

Momentum trading

 

Algorithmic-backed momentum trading is now more commonplace, allowing automated services to constantly analyse and react to momentum-impacted price movements. The more widely appreciated strategy will benefit from continuing momentum – minutes, hours or even days. However, high-frequency trading algorithmic strategies can execute numerous sales in a split second, taking advantage of price movements over a much shorter period of time.

 

Trend analysis

 

As they say, the trend is your friend, whether looking at moving averages, trading volumes or short-term movements, prompting overbought or oversold positions. The key to successful trend analysis trading is to buy at the bottom and sell just before the trend turns and other sellers emerge. Using cutting-edge algorithmic software, it is possible to stay one step ahead of your (non-automated) peers.

 

Mean reversion

 

While often used as a supporting trading strategy, mean reversion is based on the principle that prices will eventually return to their average over time. Similarly to trend analysis, this software will identify overbought and oversold positions, allowing traders to go long and short of particular stocks.

 

Weighted average pricing

 

This is an investment strategy, often referred to as volume-weighted average pricing, which analyses trading volumes and transaction prices to identify the average price of a stock. This is calculated by looking at trading volumes, the stock price high, low and close over a particular period, which is then compared with daily volumes. When a stock is trading above its weighted average pricing calculation, this is seen as bullish and bearish if below the indicated figure. This strategy can also indicate when to attempt relatively large transactions, which might typically cause significant price movements and volatility.

 

Statistical arbitrage

 

In years gone by, when companies had dual listings on different stock markets, it was often possible to exploit arbitrage situations where one price was out of sync. The introduction of electronic global trading reduced significant statistical arbitrage situations, but algorithm trading, potentially in huge volumes, allows automated systems to benefit from often minute valuation discrepancies. It is also possible to trade pairs, such as currencies, to exploit potential arbitrage situations.

 

Why markets need algorithmic trading

 

There will forever be disagreements and arguments regarding the ethical nature of algorithmic trading, but one thing is obvious; algorithmic trading is critical to market efficiency and liquidity. The ability to identify and deal on arbitrage situations helps ensure market efficiency. Constant relatively quick trading will also assist with liquidity, ensuring that market prices are more indicative of the underlying fundamentals and close to their perceived fair value.

 

On the flip side, many people will argue that algorithmic trading, often using expensive cutting-edge technology, is not available to the masses and, therefore, unfair. In reality, there are significant regulatory restrictions on the use of algorithmic trading strategies to reduce undue market influence. However, they are here to stay, and they have a vital role to play.

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