Electronic Trading : Work, How to Start, Strategy & Benefits

What is Electronic Trading?

Electronic trading deals with buying and selling financial instruments online using computer programs. You can trade things like bonds, money, stocks, and goods over the Internet through a middleman or directly with other traders. Instead of the old-fashioned way of trading on a trading floor, electronic trading lets you trade from wherever you are. To start, you need to set up an account with a brokerage firm and share some personal and financial information. When you want to make a trade, the brokerage works with stock exchanges to make it happen, all done through computers. This system can handle lots of trades super quickly.

Geeky Takeaways:

• Electronic trading is about buying and selling financial assets online using electronic trading platforms.
• Market insights aid in formulating effective strategies aligned with market dynamics and future trends, enhancing trading success and profitability.
• Lack of availability guarantees, disclaimers of liability, unknown or changing terms, handling of data concerns, unauthorized credential use, and compatibility issues with complex funds pose potential risks to traders.

Types of Electronic Trading

1. Mobile Trading: Traders can trade on the fly using their smartphones and their mobile trading apps. These apps empower traders to execute trades from anywhere, whether they’re out and about or away from their desks at home. Some firms even provide real-time data feeds through these apps, ensuring traders stay informed even on the move. A study conducted by Accenture suggests that nearly half of all retail investors are expected to engage in some form of trading via smartphones within the next five years, underscoring the profound influence of mobile trading on market dynamics.

2. High-Frequency Trading (HFT): HFT relies on sophisticated algorithms to analyze trading data and execute trades in mere fractions of seconds. HFT platforms empower traders to place thousands of orders simultaneously and monitor multiple markets at once, enabling them to execute trades electronically with lightning speed, often before the market officially opens. HFT gained prominence post-2005, coinciding with regulatory changes initiated by the Securities and Exchange Commission (SEC) to modernize financial markets. Initially thriving, HFT proprietary traders have since consolidated, expanding their strategies beyond equities into FX, ETFs, and commodities trading advisors.

3. Algorithmic Trading: Electronic trading platforms have become increasingly prevalent, offering traders the ability to execute large blocks of shares in milliseconds rather than hours. This rapid execution allows traders to swiftly enter and exit positions without waiting for orders to fill. Algorithms play a pivotal role in algorithmic trading, guiding decisions on order submissions and expenditures. At its core, algo trading involves traders developing computer software using mathematical formulas to determine buy and sell prices. Whether based on technical analysis, fundamental factors such as earnings reports and economic indicators, or a blend of both, these algorithms automate trading decisions, enabling traders to navigate markets swiftly and efficiently.

How Electronic Trading Work?

When you decide to trade, the technology required to support the process becomes crucial. You have to choose between market orders, which execute right away, and limit orders, which can be set to execute immediately or at a later time. Investors using the system can pick from these options anytime, and it has to happen in real time. To buy or sell stocks, you need to inform the brokerage where the order was placed so they know who to contact once it’s executed. The Stock Exchange system must interact instantly with every brokerage’s system, whether selling or buying shares. It gets more complex because the electronic interface must cover every exchange where investors can buy securities, ensuring transactions are smooth and offer the best prices. Trading platforms need to keep records of transactions to prove to regulators like the SEC that trades were executed properly. The automated matching engine must handle a large number of transactions seamlessly and instantly when markets are open. Investors also need backup systems to access their accounts at any time during market hours, and they must share their account information with regulators for security purposes.

How to Start Electronic Trading?

1. Opening an Account: To embark on your trading journey, begin by opening an account with a brokerage firm. It involves providing personal details like the user’s name, address, and level of investing experience. This step enables the establishment of electronic connections between your bank and brokerage accounts, facilitating seamless transfers.

2. Research Before Trading: Before diving into trading, conduct thorough research on the security you wish to buy. Brokerage websites offer valuable resources, such as research reports and real-time quotes, to assist you in making informed decisions about your investments.

3. Understanding Order Types: When placing an order, familiarize yourself with different order types, like market orders and limit orders. The brokerage’s computer system interacts with securities exchanges to execute trades promptly, ensuring your transactions are carried out efficiently. Be sure to understand the implications of each order type for your trading strategy and risk tolerance.

4. Protecting Your Information: Rest assured that all your data is safeguarded by the Depository Trust Company, guaranteeing the security of financial transactions made by U.S. shareholders, thus ensuring peace of mind regarding the confidentiality of your information.

5. Learning Market Analysis: Gain insight into market trends and price movements by familiarizing yourself with technical analysis and price charts. This understanding will equip you with the knowledge to make informed decisions about your trades. Furthermore, consider staying updated on market news and economic indicators to enhance your analytical skills.

6. Creating a Trading Plan: Develop a comprehensive trading plan encompassing aspects such as which assets to trade, optimal trading times, risk management strategies, and more. A well-thought-out plan sets the foundation for successful trading endeavors. Regularly assess and update your trading schedule as needed to adapt to fluctuating market conditions and personal goals.

7. Practicing Trading: Before transitioning to a live account, hone your trading skills by opening a demo account. It permits you to practice trading with virtual funds, providing a risk-free environment to refine your strategies and techniques. Take advantage of this opportunity to test different trading approaches and familiarize yourself with the trading platform’s features.

8. Opening a Live Account: Once you feel confident in your trading abilities, leap forward and open a live account with the brokerage firm of your choice. Complete the required forms, undergo verification procedures, fund your account, and begin your electronic trading journey with confidence. Remember to start with small, manageable trades and gradually increase your position sizes as you gain experience and confidence in your trading strategy.

Why is Research Required for Electronic Trading?

1. Strategic Planning: Market research in electronic trading provides valuable insights essential for crafting effective strategic plans. By delving into market dynamics, firms can develop strategies that not only capitalize on current trends but also anticipate future shifts, ensuring long-term success and sustainability.

2. Competitive Edge: Understanding competitors’ tactics, trading volumes, and technological capabilities empowers firms to benchmark their performance and strive for superiority in the market. Leveraging insights gained from market research enables businesses to detect areas for improvement and refine their strategies to gain a competitive edge.

3. Risk Mitigation: A comprehensive understanding of market volatility and regulatory landscapes enables businesses to assess and mitigate risks associated with electronic trading effectively. By proactively identifying potential threats and vulnerabilities, firms can implement robust risk management strategies to safeguard their investments and maintain stability in the face of market uncertainties.

4. Innovation and Adaptation: As new technologies emerge and regulations evolve, electronic trading market research guides businesses in innovating and adapting to these changes. By staying current with technological advancements and regulatory developments, firms can proactively adjust their trading platforms to ensure relevance and resilience in the ever-changing market landscape.

5. Investment Decisions: Firms rely on electronic trading market research to inform their investment decisions. Insights into market sentiment, liquidity, and asset valuation empower traders to make informed choices that maximize returns and minimize losses. By leveraging market research findings, businesses can optimize their investment strategies, capitalize on lucrative opportunities, and mitigate potential risks.

Strategy for Electronic Trading

1. Trend-Following Strategies: Algorithmic trading often employs trend-following strategies, which track channel breakouts, price level shifts, moving averages, and other technical indicators to identify favorable trends. These strategies are straightforward to implement through algorithms as they don’t involve making predictions or forecasts. By relying on occurrences of desirable trends, such as using 50- and 200-day moving averages, algorithmic traders can capitalize on market momentum with ease. 

2. Mathematical Model-Based Strategies: Mathematical models, such as the delta-neutral trading strategy, enable algorithmic trading based on options and underlying securities. By maintaining a balance of positive and negative deltas, these strategies aim to mitigate risk and capitalize on market fluctuations. Continuously refine mathematical models to adapt to changing market dynamics and improve trading performance.

3. Arbitrage Opportunities: Arbitrage involves exploiting price differentials between markets to secure risk-free profits. Algorithmic trading can identify such opportunities, such as buying a stock at a lower price in one market and selling it simultaneously at a higher price in another. This strategy can also apply to stocks versus futures instruments, leveraging algorithmic systems for efficient order placement and profit realization. 

4. Trading Range (Mean Reversion): Mean reversion strategies capitalize on the notion that asset prices tend to revert to their mean value over time. Algorithms identify and define price ranges, automatically execute trades when prices breach these boundaries, and exploit profit opportunities. Regularly adjust price ranges based on market volatility to optimize mean reversion strategy performance.

5. Index Fund Rebalancing: Periodic rebalancing of index funds presents profitable opportunities for algorithmic traders. By anticipating trades associated with index fund rebalancing, traders can secure profits ranging from 20 to 80 basis points, depending on the index fund’s composition. Algorithmic trading systems facilitate the timely execution of these trades at optimal prices, maximizing returns. 

6. Volume-Weighted Average Price (VWAP): The VWAP strategy divides large orders into smaller, dynamically determined chunks based on stock-specific historical volume profiles. By aiming to execute orders close to the volume-weighted average price, this strategy minimizes market impact and optimizes execution. Implement real-time adjustments to VWAP algorithms based on changes in trading volume and liquidity conditions.

7. Beyond the Usual Trading Algorithms: Specialized algorithms, such as sniffing algorithms, go beyond typical trading strategies by identifying algorithmic activity on the opposite side of a large order. This intelligence permits market makers to capitalize on large order opportunities, albeit regulated to prevent front-running practices, ensuring fair and legal market operations. Develop sophisticated algorithms with built-in market intelligence to identify and exploit emerging trading opportunities effectively.

8. Percentage of Volume (POV): POV algorithms adjust order sizes based on the defined participation ratio and market volume. This approach ensures gradual order fulfillment while adapting to changes in market conditions and optimizing execution efficiency. Monitor market volume trends and adjust participation ratios accordingly to maintain optimal trading performance.

9. Time-weighted Average Price (TWAP): TWAP strategies distribute large orders evenly over predetermined time slots, aiming to execute orders close to the average price between the start and end times. By minimizing price fluctuations during execution, TWAP strategies help traders achieve favorable outcomes. Regularly review and optimize TWAP parameters to adapt to changing market conditions and improve execution efficiency.

10. Implementation Shortfall: Implementation shortfall strategies aim to reduce order execution costs by trading off real-time market conditions. By adjusting participation rates based on price movements, these strategies seek to minimize both order costs and opportunity costs. Continuously evaluate execution performance and refine implementation shortfall strategies to achieve cost-efficient trading outcomes.

Benefits of Electronic Trading

1. Swift and Efficient Trading: Electronic trading enables rapid execution of orders, facilitating quick and efficient transactions for traders. With just a few clicks, orders can be processed almost instantly, permitting traders to capitalize on market opportunities promptly.

2. Lower Brokerage Fees: Online trading platforms typically feature lower brokerage fees compared to traditional methods, resulting in significant cost savings for investors. Reduced transaction costs mean traders can retain more of their profits, enhancing overall investment returns.

3. Risk Management: Electronic trading systems provide comprehensive tools for risk management, enabling traders to monitor their investments closely and make informed decisions to mitigate risks. Through real-time tracking and analysis, traders can identify potential risks and take proactive measures to safeguard their portfolios.

4. Well-Informed Decision-Making: Traders utilizing electronic platforms have access to real-time market data and advanced interfaces, empowering them to make well-informed decisions about their investments. With up-to-the-minute information at their fingertips, traders can react swiftly to market changes and capitalize on emerging opportunities.

5. Convenience: Online trading offers unparalleled convenience as investors can trade from anywhere with an internet connection, saving time and offering accessibility. Whether at home, in the office, or on the go, traders have the flexibility to manage their portfolios at their convenience without being tied to a specific location. Take advantage of mobile trading apps to stay connected to the markets even while on the move.

Risks of Electronic Trading 

1. Lack of Availability Guarantee: Electronic trading platforms may only sometimes ensure availability, which could result in difficulties in executing trades efficiently. This lack of guarantee can lead to disruptions in trading activities, potentially causing inconvenience for users during critical market periods.

2. Disclaimer of Liability: Vendors frequently limit their liability to a minimal extent, leaving customers with scant protection in the event of system failures or errors. Such disclaimers may leave customers vulnerable to financial losses without adequate recourse in cases of vendor negligence or technical malfunctions.

3. Unknown or Changing Terms: Vendors retain the right to unilaterally modify terms, even if the initial contract appears favorable, introducing uncertainty and potential risks for users. These changes could impact users’ trading experiences and may necessitate continuous monitoring of contractual agreements to ensure compliance and mitigate potential adverse effects. 

4. Handling of Data: Some vendors may lack clear terms regarding the handling of trading and other data, raising concerns about confidentiality and data usage. Users may be uncertain about how their sensitive information is being managed and whether it is adequately protected against unauthorized access or misuse. 

5. Unauthorized Credential Use: Users are typically accountable for issues related to the unauthorized use of their credentials, including access by unauthorized individuals or misuse by employees or hackers. This places the burden on users to maintain robust security practices and remain vigilant against potential threats to their account security. 

Conclusion

Electronic trading offers individuals the convenience and accessibility to engage in financial markets from anywhere with an internet connection. While it presents numerous benefits, such as swift transactions and lower costs, traders must also be aware of potential risks and conduct thorough research to make informed decisions and mitigate challenges. With proper understanding and preparation, electronic trading can be a valuable tool for investors to manage their portfolios and pursue their financial goals. 

Electronic Trading – FAQs

Is online trading safe?

Experts affirm that online trading is just as safe as offline trading because financial transactions are always protected.

What percentage of trading is electronic?

According to the latest Triennial data, around 60% of trades are conducted electronically, indicating a stable trend in the process of electronification.

Can you provide an example of electronic trade?

Electronic trading encompasses various products, such as currencies, commodities, derivatives, stocks, bonds, and more. These trades are facilitated by financial intermediaries like brokers, market makers, investment banks, or stock exchanges.

When did electronic trading start in India?

Internet trading commenced in India on April 1st, 2000, with 79 members seeking permission to engage in online trading.