Have you ever heard of algo trading, robo-trading, or investment robots? Wondering if it’s a scam? Let me tell you the truth straight up. There are indeed many robots being sold online that are scams. This article might offend some people, but I’m committed to the truth, so it’s time to lay it all out and discuss everything about the algo trading universe.

Let’s start from scratch. When we talk about Algo Trading, we’re referring to buying and selling financial assets automatically through computerized algorithms, rather than manually by a human being. “But isn’t this tool programmed by a human?” Not necessarily. Nowadays, we have increasingly sophisticated artificial intelligences that collect data from asset trading on stock exchanges, forex, and develop parameters based on this data for the computer to execute buy and sell orders automatically.

How Algo Trading Works

The first time you hear about algo trading, you might think, “Great, I’ll go to the beach, and my computer will make money for me automatically.” But think about it: if it were that simple, nobody would work anymore. Why would I open a bakery and hire employees if I can just sit back at home watching Netflix while a computer makes money for me?

So, what are they hiding from us? What’s the catch with these robots? Is it a scam or not? Comment below if you think robo-trading is a scam or not; I want to hear your opinion.

Here’s the deal: this area of automated trading is legitimate; it’s not a scam. But some ill-intentioned players take advantage of this area to pull off scams. So let’s separate the wheat from the chaff, and I’ll show you everything about Algo Trading, even how to avoid falling for scams by buying non-functional robots. But yes, there are robots that work. I won’t be selling you any robots in this article, as promised, and I don’t use trading robots anymore. I’ll explain why I stopped using them throughout the video. But rest assured, professionally executed automated trading does work. Let’s delve deeper into this.

All Brokerages Use Algorithms

The world of algo trading is dominated by speed, accuracy, and complex algorithms. Technological evolution has radically transformed the financial market in the last four decades.

Today, more than 60% of all trades are conducted by high-frequency trading (HFT) programs, which are automated trading strategies where computers use algorithms to execute financial transactions at high speeds.

In other words, in the financial market, buy and sell orders are no longer exclusively issued by humans but by mathematical codes that execute orders in milliseconds. And the speed of the machines far exceeds human capacity.

Nasdaq and Electronic Trading

This story of HFT began in 1983 when Nasdaq introduced electronic trading. Before that, as you may know, it was all shouting and telephone calls on the trading floor. Until the early 2000s, less than 10% of trades in the financial market were conducted by HFTs. Today, more than half of the trades in the financial market, in general, are not made by humans but by computers.

But are HFTs good for the financial market, or do they harm it? Well, proponents will argue that HFTs increase market liquidity and even market efficiency by reducing spreads. But critics will point out situations like the Flash Crash in May 2010, when algorithms, reinforcing each other, caused the Dow Jones to plummet nearly a thousand points.

Whether you like it or not, HFTs are here to stay. But how do they work?

Parameter Definition

The first thing when creating a trading algorithm is to define the parameters for when the algorithm should act. These are rules based on price, volume, timing, technical indicators—various mathematical models.

Once the algorithm is taught to identify market opportunities, when to buy and sell, and how to manage risk, it is linked to real-time data, either directly on the platform or through API with the brokerage, for the program to constantly analyze various markets, such as stocks, futures, etc.

When the algorithm identifies a specific condition that matches the pre-established rules, it automatically triggers a buy or sell order. This can happen in milliseconds, much faster than a human trader could react.

Advantages of Algo Trading

So, we already see the first advantages that algo trading offers: a computer program can monitor multiple markets simultaneously and make decisions faster than a person, without taking up your precious time. This brings much more agility in order execution.

It also eliminates the emotional factor, which often breaks a trader’s bank when it comes to a human being operating: we have fear and greed ingrained in our system, while a computer program will make decisions purely based on the technical parameters you’ve configured.

Negative Side of Algorithms

But the downside of algo trading is precisely that you don’t have total control over that operation. If a black swan event occurs, an event that diverges from the historical pattern of the asset, and the programming cannot include that in the decision-making process, as it is trained with past data from that market, the result can be a significant loss.

Not to mention machine dependency; you lose agency over your operations and stop learning while trading.

Positive Example: Jim Simons and Renaissance

Let’s see some positive and negative examples of using algorithmic trading. The most emblematic case, and one of the pioneers of this art, is Jim Simons. He was a mathematician who, in his spare time, broke Soviet secret codes. In the late 1980s, already in his 50s, he decided to open the Renaissance hedge fund, just when Warren Buffett and Ray Dalio were teaching to trade based on fundamentals, a qualitative approach. 

Jim Simons hired only physicists and mathematicians to build predictive models and became a billionaire, with returns higher than the traditional names in the market. Today, Renaissance is the 3rd largest hedge fund in the world.