Algo trading uses a computer program that follows a defined set of instructions, an algorithm, to place a trade. Supposedly, the program can generate profits at speeds and frequencies faster than a human trader can. Algorithmic programs are usually written by teams of people over a period of time in order to maximize profits and trades for a company.
A single trader usually cannot compute an entire algorithm that understands their preferences in the time it’s worth it to use the program. The reason why companies use them is because the energy and resources used to compute them make it worth it for a company to take advantage of its benefits. It is almost impossible for a human to use one of these algorithms unless they are stealing proprietary code from a company.
However, there are many more logistical and practical reasons why individuals do not use algo trading for themselves outside of the time and energy it would take to create such an algorithm. Below are the reasons why individuals use algo trading for companies, and not themselves.
Scale and Market Access
One of the immediate benefits of being a part of a trading firm is scale. When there is significant capital available to invest in the market, brokers will begin to take your calls. Scale usually translates directly into market access. A larger firm can have multiple departments and different teams of brokers working in different markets.
Some global markets are too expensive and/or too illiquid to trade at a smaller scale. Considering you might have the funds to trade in a certain market, it might not make sense for a broker to invest with you because of the size of your individual account. It obviously helps to have more money available to invest, but in the end it might not be worth it to invest at all if an individual’s account isn’t large enough. You can make a list of the limitations of investing just based on the capital available for a market.
A larger firm usually has more resources, personal, and access to capital to make investments worth it where individuals have nowhere near access to the same amount of resources for a trade.
It is expected that a larger trading firm would have plenty of infrastructure which includes high quality data, dedicated programmers and access to plenty of resources. Data in the stock market is extremely important, for example, high quality live market data for the US markets can cost tens of thousands of dollars per month. A larger firm can afford these costs and still reap profits.
To shed a light on how big the data market is, the alternative data market was worth about $200 million in 2017. In 2019, fund managers were projected to spend over $1 billion on alternative data sources. These types of expenses seem ridiculous, but when they generate an edge in the market over other firms, it essentially pays for itself. On an individual level, it would be very hard to source and process these data points on your own. In addition to the data a large firm pays for, they also incur costs associated with their software teams; Another cost an individual usually can’t afford, software teams help with upkeep of online software for the firms and prevent bugs from ruining trading strategy. There are levels of infrastructure that an individual simply cannot attain, without huge sums of money and personnel.
Algorithmic trading is not easy, it requires demanding, creative and time consuming work in order to perfect. Working on a team that writes the program for algorithms entails being tasked with extremely bright, high-achieving and like-minded individuals.
These are people who have graduated from prestigious universities, have expertise in math, physics, engineering, or all three. The guidance, expertise and experience gained from tackling market problems on one of these algorithm developing teams is invaluable.
An individual cannot do the work that an entire team of extremely capable and bright individuals can achieve. Once the algorithm is created and the work is finished for these bright individuals, the final product will help brokers and traders in the firm do amazing work, which is extremely rewarding. An individual cannot create the same algorithm in the same amount of time it takes for an entire team of college graduates to do so.
Starting Your Own Firm
Starting your own firm is similar to starting your own business. Not all businesses turn into wild success stories, not all make enough money to make grand profits, and not all businesses take just a few years to get off the ground. Starting your own firm takes a certain kind of passionately driven, hardworking and obsessive personality in order to see your idea through.
On top of creating your own algorithm, the time it took for one person to create their own source of algo trading, it would be time for them to retire. You cannot be a regular joe who decides he wants to start his own brokerage firm out of a whim. You have to have a certain level of credibility and track record that other people can support, in order for people to vouch for you. Starting your own brokerage firm specifically, you must be prepared for your job becoming 90% investor relations and about 10% strategy development.
Hundreds of hedge funds are launched and close every year, which doesn’t give an individual good chances at creating a successful firm from the ground up. Succeeding on your own doesn’t mean you have to start your own firm, individuals can provide crowdsourcing platforms for others to utilize in their trading.
At the same time, eager investors would love to start their own firm, and only a handful of them become successful starting their own firm. It takes a particular personality, drive and credibility for someone to start their own brokerage firm.
Algo trading has begun to change the financial sector as a whole, replacing humans with algorithms that make daily trades in the Forex market. In many industries such as hospitality, security, and service, robots and computers have replaced humans, while the financial sector seems to be next. Algo trading is an incredible tool large trading firms have begun to take advantage of, so why can’t individuals use the same technology? To start, individuals do not have the same scale and market access that larger brokerage firms have.
Larger trading firms have teams and different departments that cover many markets within Forex, while one individual simply cannot keep up with the same work teams of traders can do. Next, individuals have no where near the established infrastructure a large trading firm has.
A large brokerage firm has access to expensive high quality data, dedicated programmers for algo algorithms as well as diverse resources. Individuals would not have the means to meet the same level of organized infrastructure to generate the level of profits a large firm does. There is also a level of a rewarding environment within a development team or department that an individual cannot experience by themselves. In addition, for an individual to accomplish what a large trading firm has, they would need to start their own firm, which would take innumerable resources and time.
By the time an individual built a successful trading firm, the firm they were competing against had made millions and millions more in profit. In the end, individuals don’t use algo trading because it requires a lot of people to create a final product. One individual cannot create an entire algo trading program in enough time where it is worth it to apply to the market. Algo trading has been created with the help of teams and departments of people, something a single individual cannot accomplish