What is Program Trading?

How Does it Work?

A few algorithms are set for executing a program trading, such as selling stocks in a portfolio if the stock valuation crosses 10% of the overall portfolio value. Once the algorithms are set, the software contracting securities in the market places orders as mentioned in the program if the required conditions meet. This way, the applications keep running and executing orders independently without external support.

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Types of Program Trading

Some prominent and popular types are mentioned below: –

#1 – Principle Trades

A trader generally buys a group of stocks, mainly replicating popular stock indexes Stock IndexesThe stock index, which is also known as the stock market index, is a tool used to determine the performance of shares/securities in the market and to calculate the return on the stock of their investment investors use it to have knowledge about the performance of investments and access the total value they possess.read more such as the S&P 500. Then, as the retail customers purchase it, the principal traders release the trades in the market and fulfill the customers’ orders. In this way, apart from earning a commission, a brokerage is also made.

#2 – Basis Trades

Another type of trading is known as basis tradesBasis TradesBasis trading is a monetary trading strategy that involves purchasing a specific financial instrument, such as a stock or a commodity, and then selling its related derivative.read more. In this case, a prominent investor generally takes a position in similar securities to milk the price inefficiencies. This strategy is also used in contra trades where one security is bought, and a similar one is sold to reduce the exposure in the market.

#3 – Contra Trades

The contra trades are used in different markets too. Such as, to cover the position of one security in the physical market, one could sell an option or futures if the required security is not available at the estimated price. Then, later on, using the leverage of futures and options, the original position is squared off with less turbulence due to the back of derivatives.

Examples of Program Trading

  • In 2018, it stated that approximately 55% of all the trading on a typical day was done with the help of an algorithm, and on some days, it went up to 90%. For instance, let us assume that a Hedge FundHedge FundA hedge fund is an aggressively invested portfolio made through pooling of various investors and institutional investor’s fund. It supports various assets providing high returns in exchange for higher risk through multiple risk management and hedging techniques.read more wants to purchase a basket of securities at a predetermined price. In one go, it programs via algorithms. As the stated criteria meet, the securities are obtained; similarly, these could be sold. Umpteen strategies are plying the market in today’s world that the program trading could execute.Another example could be the automatic buying or selling of securities to maintain the portfolio balance. The program could be taught to buy or sell the security once the individual security value goes up or down the 10% mark of the total portfolio.

Program Trading Strategy

Such trading happens in a large volume and requires a strategy to perform. First, a strategy or a pattern is observed or devised, and then programs are coded. Once the entire setup is ready, these programs wait for the required trigger point, and as soon as the market meets the coded criteria, trade happens. Humans do monitor the process of the programming and processing of businesses.

Advantages

  • Program trading is unimaginably fast, and various trades can be placed in microseconds. But, on the other hand, in arbitrage, a buy and sell order needs to be put simultaneously. Even the slightest delay could eradicate the profit marginProfit MarginProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. read more. So, in these situations, algorithm trading is used.Large or institutional investorsInstitutional InvestorsInstitutional investors are entities that pool money from a variety of investors and individuals to create a large sum that is then handed to investment managers who invest it in a variety of assets, shares, and securities. Banks, NBFCs, mutual funds, pension funds, and hedge funds are all examples.read more generally use hedge funds and mostly place orders according to a set strategy. However, sometimes multiple stocks are required to buy in one go. Thus, program trading comes in handy in these circumstances.Because of its fast-paced order placing capabilities coupled with workings on predetermined strategies, the algorithm trading Algorithm TradingAlgorithmic trading is an automated buying and selling process with a programmed algorithm to determine the price, volume and timing of order. Algo-trading is a high-frequency trading technology that enables the exchange of stocks and other assets in the financial market.read more helps the traders or arbitrageurs exploit the opportunity of mispricing in the market.Again, as machines perform the program trading, it lacks human emotions and hurdles. Trading from the automated route does not involve indiscipline, fear, greed, and other emotions posing a barrier to the desired strategy.

Disadvantages

  • Many market participants complained about extreme volatilityVolatilityVolatility is the rate of fluctuations in the trading price of securities for a specific return. It is the shift of asset prices between a higher value and a lower value over a specific trading period. read more in the decade leading to the 1990s, mostly caused by program trading. In a wake-up call, NYSE has imposed certain restrictions in times of massive volatility. Depending upon the security price, program trading is halted or subsided. It is widely known as circuit breakers. It could restrict the strategies or efficiency of the trading at times.Program trading is quite expensive regarding data feeds and the personnel to run. Therefore, all traders cannot avail themselves of these options as the costs are quite steep.Irrespective of speed, accuracy, and punctuality, it still suffers technical and mechanical failures. The programs are not infallible and can make errors due to technical glitches.

Conclusion

It is widely used across markets and countries and provides an altogether different paradigm for trading. Though expensive, competitive, and heavily monitored, it grows as the days pass. Also, due to technological advancements and active participation in the securities markets, the days are not far when it will become a norm in the trading fraternity.

This article is a guide to Program Trading and its definition. Here, we discuss the system trading, program trading strategy, work, types, and examples. You may learn more about our articles below on accounting: –

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