Stock Trading
Oct. 28, 202111 min read

What is Algorithmic Trading? The Definitive Guide

Tim BohenAvatar
Written by Tim Bohen

Algorithmic Trading: Key Takeaways

  • Algo trading isn’t the ‘answer’— but find out how it can be part of your strategy…
  • What you must know about algorithms and market inefficiencies…
  • You can’t ‘set it and forget it’ with algo trading. Learn the essentials today!

Take StocksToTrade for a 2-week test drive — with our Oracle algo tool!

Algorithmic trading (algo trading, if you’re trying to sound cool) is a type of automated trading. It’s a mathematical approach that can leverage your efficiency with computing power. 

Listen, I like my human brain. It can do things an algorithm can’t do. But it isn’t a contest. Let’s see what algos can add to your trading strategy!

What Is Algorithmic Trading?

© StocksToTrade

Algorithm + trading = algorithmic trading. 

But … what does that mean, exactly?

An algorithm is a set of rules for solving a problem — typically with a computer. You can use them for algorithm-based trading … but algorithms are everywhere!

Algorithms tell Google what websites to show in search — as well as the ads you’re most likely to click.

If you know how to trade with algorithms, you can put them to work for you…

Understanding How Algorithmic Trading Works

Anything you can do with technical analysis, you can automate with an algorithm.

If you like to trade moving average crosses, there’s an algorithm for that. 

If you’re looking for the best entries on volatile stocks … that’s exactly what StocksToTrade’s awesome Oracle tool does!

More on that later.

Why Use Algo Trading?

What’s so great about algo trading? Here’s what some traders dig about it…

1. Navigate Fast and Small Changes in the Market

A computer’s timing is probably better than yours. With algos, you can time trades to help you better navigate quick price changes.

2. Make Data-Based Decisions

Dealing with emotion is a constant struggle for traders. Algorithms can help take some of the guesswork out of stock trading so you build solid trading plans.

3. Stick to Your Trading Plan

Once you build a plan, you gotta stick to it. The mathematical approach of algorithmic trading can keep you from making rash decisions.

4. Reduce Human Error 

As a human, you might make a bad judgment on a trading signal. This is less likely to happen with algorithmic trading.

5. Find What’s Working

If certain setups tend to work better for you, you could set them up as an algorithm.

6. Save Time

I know, you’re busy. A tool like Oracle can instantly assemble your watchlist, give you entries and exits, and a snapshot of sentiment.

Can You Make Money With Algorithmic Trading?

I don’t love thinking about any kind of trading this way…

That said, ANY trading approach needs to work. Profits are the surest sign of that!

Who Can Benefit From Algo Trading the Most?

The basic requirement for any trading strategy? You need to have one.

If you’re just trading random stocks based on alerts, algorithms, or Twitter … you’re going to lose.

How Do You Start Algorithmic Trading?

Some traders code their own algorithms. Others plug in a premade algo like StocksToTrade’s Oracle.

Here’s the step-by-step if you want to wade in…

How Do You Build an Algorithmic Trading System?

Do you even code bro? That’s in your future.

You’ll have to learn the algorithm builder’s coding language to input the conditions you want. But first, there’s a bit of work…

What Skills Does an Algo Trader Need To Have?

To build a successful algorithm, you’ll need to backtest the algorithm’s strategy. This is the same dedication you need with a human strategy…

With algo trading, the temptation to ‘set it and forget it’ becomes even greater. Keep journaling your trades, studying charts, and refining your strategy instead.

Common Algo Trading Mistakes

Here are a few things to watch out for:

  • A flawed algorithm. Make sure to thoroughly test and review your algorithm’s trades. 
  • Not accounting for slippage and commissions. Small trading edges can vanish with these costs and fees.
  • Taking on too much risk. Think your algo is bulletproof? It’s not. Keep reviewing the results and keep your risk in check.
  • Interfering with the algorithm. Not following through on your trading plan is a mistake for ANY trading strategy.

Algorithmic Trading Strategies

© StocksToTrade

Curious about algorithmic trading strategies? Here are some popular ones…

#1 Trend-Following Strategies

One of the most common strategies traders use is to follow trends by using indicators.

This method is popular because it doesn’t involve any complicated forecasting. Basically, you initiate a trade when a stock meets your desired trend criteria.

#2 Mathematical Model Algorithmic Trading

This method relies on homebrew indicators.

#3 Volume-Weighted Average Price (VWAP)

VWAP helps determine the average price of a security over a period of time.

This can help you pick the best entry and exit points. It can also help you decide whether an aggressive or cautious approach is in order. Here’s how I prefer to use VWAP.

How is VWAP calculated? It’s easy. Add the dollar amount for every transaction, then divide by the volume traded.

Easier still — get a top-shelf trading platform like StocksToTrade. A VWAP overlay is just one click away.

#4 Percentage of Volume (POV) Algorithmic Trading

This volume-based approach is designed for minimum market impact.

It keeps placing smaller orders until the order is completed.

#5 Time-Weighted Average Price (TWAP)

Instead of breaking up your order by volume, TWAP breaks it up by time.

It is also designed to minimize market impact.

#6 Index Fund Rebalancing

Index funds also have algorithms. When their holdings don’t match the underlying index, they need to be reshuffled.

These periodic upheavals can present an opportunity for algo traders.

#7 Arbitrage Opportunities

Occasionally, prices differ between exchanges in dual-listed stocks. Exploiting such inefficiencies can potentially give algo traders an edge.

#8 Mean Reversion

This strategy is based on the idea that highs and lows won’t last. By targeting the mean, this strategy seeks to profit off market fluctuations.

#9 Market Making

Market makers also use algorithms. Some of these algos ‘sniff out’ what’s happening on the other side of a trade…

These algorithms are sometimes used for questionable practices like front-running more profitable orders. Something to watch out for.

#10 Implementation Shortfall

This strategy takes advantage of slippage and fees that aren’t accounted for. It uses real-time market information to minimize execution costs. 

#11 Algorithmic Trading Sentiment Strategy

This strategy uses bearish and bullish indicators to buy high and sell higher, or vice versa.

#12 Statistical Arbitrage (Stat Arb)

This is a scattershot mean reversion approach. Using the same basic strategy, stat arb can trade many securities at the same time.

What’s the Best Algo Trading Software?

© StocksToTrade

You know I’m always on the side of keeping it simple…

And it’s pretty clear I’m a fan of both StocksToTrade and its Oracle tool. (Sure, I’m biased.) You can take it to the next level with my Daily Market Profits service. 

It’s human PLUS machine. That’s the kind of algo trading that can benefit EVERYBODY — especially part-time traders and newbies.

Every morning I fire up Oracle. It starts building a watchlist in premarket. Its bullish/bearish indicator helps me see sentiment when things are moving fast.

When I see a lot of red on Oracle, I know it’s a day to be extra choosy and extra cautious. When I see a lot of green, I know I need to get my watchlist down to the top contenders.

Using Oracle, I send out a watchlist of volatile stocks to subscribers, with entries and exits for each.

This can be super helpful for busy traders, and those just starting out.

Learn more about Daily Market Profits here!

Check out the video below to see all the things I LOVE about our pet algorithm!

Software Requirements

Relax … You don’t need a supercomputer to run algorithms!

Use StocksToTrade

StocksToTrade is the engine behind Oracle — and a powerful trading platform on its own!

You don’t have to choose. Oracle comes included with a StocksToTrade subscription. Take it out for a test drive — sign up for your two-week trial here.

Is Algo Stock Trading Legal?

Unless you’re a high-frequency trader front-running your orders, you’ll be fine.


Algorithmic trading is a numbers-based approach to filtering stocks. It helps approach trading in a mathematical way. 

Not only can it help traders save time, but it can also help remove human error from the equation!

But remember: there are never guarantees in the market. 

Algorithmic trading can help you make informed decisions. But there are too many factors for it to be spot-on all the time. 

If you decide to use algorithmic trading, it should be just one part of your strategy. For the right kind of trader, it can be a good one.

Have you tried algorithmic trading? Let me know in the comments!