Should Retail investors use trading algorithms?
Can algorithms improve a retail investor’s trading performance? The answer is “absolutely!” Let’s take a look at the advantages of automated trading through algorithms over trading manually.
The advantages of algorithm trading
The well-known advantages of algorithm trading are its fast execution, accuracy, and lower transaction cost . These advantages are associated with the improving technique of automated trading. However, there are also other benefits if you look from a different perspective.
Capacity
Due to capacity restraints, institutional investors seldom trade in small, emerging markets or small cap companies. Thus, this provides an opportunity for retail investors to avoid competing with large institutional investors and earn more profits. The stock price of small cap companies is very volatile and easily affected by markets shocks. This allows investors to benefit by ‘buying low and selling high’. Algorithm trading can help retail investors monitor markets real time and execute their trading strategies faster.
Liquidity
Because institutional investors trade large quantities of stock, they can only trade in highly liquid stocks. Thus, they bear a “liquidity tax”, which is an added cost of trading by being overcrowded in a certain stock, and thus, artificially driving up the stock’s price. Retail investors on the other hand, care less about the asset liquidity because of their small trading volume. Thus, algorithm trading is helpful for retail investors to quickly execute their orders against the larger institutional investors in the market.
Less legal limitation & Flexible strategy
Due to legal limitations, large institutional investors have less freedom in their trading strategy compared to retail investors. For example, institutions have constraints on short selling or position limits resulting from the legal inability of many arbitrage or pair trading strategies.
Discipline
Compared to institutional funds, retail traders are relatively affected by their emotions. Although this personal emotion, or gut feeling, could be right or wrong, it definitely negatively influences the performance and effectiveness of the retail trader’s trading strategy. Automated trading can prevent the intervention of emotions while effectively executing trading decisions based on discipline.
At the end of the day, automated trading offers a chance for a good night’s sleep which retail investors often struggle with as they know that they cannot control their investments 24/7. By enabling computerized execution of their intentions and strategies we effectively resolve the trading deficits brought about by human response time and emotions.
