What is program trading?
Algorithm, computers, and a little human intervention are the three things that revolve around the term computer trading—what a time to be alive when computers can do something with little to no human supervision. Today, we already have program trading where the algorithms involving the trade of a basket of stocks in massive volumes and significant frequencies are generated by computers. Although humans still need to monitor this algorithm from time to time, the programs are the ones that create the trade instead of humans. But if there is a need to shut down the program, the human can still intervene and deactivate or activate it again.
The NYSE defines program trading as buying and selling a group of 15 or more stocks with a $15 million market value or more. Also, they said that this is a part of a coordinated trading strategy. Other people also refer to program trading as portfolio or basket trading. In this kind of trading, orders are directly placed and executed based on a predetermined set of instructions.
Let us cite an example.
Some investors and traders wish to execute a massive volume of trades. For example, we have fund managers and mutual fund traders. Hence, they use program trading to do that. This type of trading is helpful for them because there is less risk when placing trades simultaneously while maximizing the returns by exploiting the market inefficiencies. Let us say that the trading algorithm bought an 80-stock portfolio in the first hour of the day. This would not be as effective if a human were to place many orders only by hand.
More and more people prefer program trading.
If we looked back in 2018, program trading was used in 50% to 60% for all stock market trades during regular trading days. This percentage is significant enough since it is already more than half. But in 2021, program trading accounted for more or less 70% to 80% of all stock market trades during a regular trading day. These figures can still rise to 90% when there is extreme volatility.
Different firms, different strategies
Some firms that use program trading may have a strategy to execute massive trades per day, while some would instead execute only every few months. Every firm has a different take on program trading. Day trading programs are more active than investing programs.
Before, people pointed their fingers at program trading because they believed it started extreme volatility and market crashes. So, the NYSE came up with rules. They prevent program trade executions at a particular time to also avoid volatility. These restrictions are called trading curb or circuit breakers.
Why would one prefer program trading?
People who tried program trading realized many things about their way of investing. They had this theory that trading a diversified portfolio of securities is a way to lessen investment risks. Institutions hold and trade massive equity, and program trading makes it possible. They find it easier to incorporate their different strategies. Also, program trading makes trading cheaper, more efficient, and worthwhile, thanks to technological advancements.