What is an algorithm?
Although it is difficult to formally define the word “algorithm,” suffice to say it is “a set of rules that precisely defines a sequence of operations. This includes all computer programs, even programs that do not perform numeric calculations.”
It is a set of instructions used to accomplish a given task.
Algorithms are used to evaluate design tradeoffs, to assess control systems, and to find patterns in data.
Here is the definition from Wikipedia. An algorithm is an effective method that can be expressed within a finite amount of space and time and in a well-defined formal language for calculating a function. Starting from an initial state and initial input (perhaps empty), the instructions describe a computation that, when executed, proceeds through a finite number of well-defined successive states, eventually producing “output“and terminating at a final ending state. The transition from one state to the next is not necessarily deterministic; some algorithms, known as randomized algorithms, incorporate random input.
To make a computer do anything, you have to write a computer program. To write a computer program, you have to tell the computer, step by step, exactly what you want it to do. The computer then “executes” the program, following each step mechanically, to accomplish the end goal.
When you are telling the computer what to do, you also get to choose how it’s going to do it. That’s where computer algorithms come in. The algorithm is the basic technique to get the job done.
Algorithms in Trading
A trading algorithm is the rules you would follow when entering or exiting a trade but transcribed to a programming code.
Wikipedia says “Algorithmic trading, also called automated trading, black-box trading, or algo trading. Algorithmic trading is widely used by investment banks, pension funds, mutual funds, and other buy-side (investor-driven) institutional traders. These institutions divide large trades into several smaller trades to manage market impact and risk. Sell-side traders, such as market makers and some hedge funds provide liquidity to the market, generating and executing orders automatically.”
Wikipedia’s description states the computers not only scan markets for setups, according to an algorithm but that the computer will actually do the trading for you as well, called algorithmic execution. At QiT we will scan and post setups but leave the actual trading to our members. We do not do any trading at all, only give you the stock suggestions that setup according to the rule set.
One of the most important aspects of trading with algorithms, above all else is:
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