Algorithmic Trading or automated trading is the term used for electronic stock market trading that uses a complex computer algorithm to control the buying and selling of stocks, shares and other investment products. The computer program or algorithm deals with certain key aspects or parameters for trading these can include; quantity, time or price. The use of these complex computer programs removes the need for human invention in trading and therefore speeds up and streamlines the process.

Automated trading is used by many large hedge funds, pension funds and mutual funds allowing them to divide many large scale trades into small chunks and therefore minimise risk and exposure in the market place. The use of high speed technology is central to the success of Algorithmic Trading as it allows the end users to partake in High-frequency trading.

Speed is vital in the success of high-frequency trading and the security and reliability of the technology is vital. Typically the traders with the fastest execution of trades, those that can process the data at the quickest speeds will be the most profitable. In 2009 it was estimated that more than 50% of all trades carried out on the stock exchange where completed using algorithmic trading methods.

Computer based stock trading has been on the rise since the early 1970s but didn’t really take hold until the increases in computer processing power in the 1980s. The equity and futures markets were the leaders in using technology to process large scale trades on a daily basis. The knock on effect of the use of technology has been a decline in the number of traders employed as computer programs and high speed Ethernet connections have replaced these jobs.

The increased use of automated trading is a direct result of the requirement of the finical markets for higher levels of liquidity. The high speed of the trades allows for an increased through put in the market and this in turns increase the general levels of liquidity. Changes in the minimum tick size from 1/16th of a dollar ($0.0625) to $0.01 per share, provided a boost to algorithmic trading by allowing for smaller differences between the bid and offer prices they decreased the market-makers' trading advantage, thus increasing market liquidity.

The majority of algorithmic trading is carried out using the Financial Information eXchange (FIX) protocol. FIX was initially created by Robert "Bob" Lamoureux for electronic equity trading between Fidelity Investments and Salomon Brothers in 1992. It has since been widely adopted by the market as a whole. FIX is used by both the sell side any buy side of the major financial markets.

As the processes of algorithmic trading have become more complex the protocols required to action them have also developed. The basic FIX protocol is now supplemented by the FIXatdl (FIX Algorithmic Trading Definition Language) the latest version of 1.1 is released to the market in March 2010.

The success of algorithmic trading can been seen in the report released in August 2009 by the TABB. The report estimated that the 300 securities firms and hedge funds that specialize in rapid fire algorithmic trading took in roughly $21 billion in profits in 2008.

Tony Heywood (c) 2010