What are the major disadvantages of algo trading?

(Last Updated On: August 4, 2011)

What are the major disadvantages of algo trading?


Look most people think Algo trading will make them money and if it does not, the whole concept should be scrapped.
But Algo trading is just the Automation of your strategies. If your strategy is not working, you cannot blame Algo trading for it. Its like you are blaming the application for not running on the computer but you have not noticed that OS used is not performing well.
Algo trading has all the benefits that other processes being automated brings in, and may be more.


It slightly depends what you mean by algo trading. If you mean high frequency and the like then some people would argue that algos skew the market. Those who can afford the people and machines to run HF strategies win at the expense of ‘ordinary’ investors. One could also argue that trends in algo-wars, where algos try to determine the trades of other entities in order to capitalise on them is leading to an arms race in which – again – those with the most resources win at the expense of others (conversely one could argue that winning at the expense of others is what happens in markets, so tough). In case you don’t already read it, the blog ‘Zero Hedge’ tends to take this kind of view of algos.

Alternatively if you are talking about algo-trading then it seems to me that the answer is one of personality. Some people may not be able to trade a fully automated system and might start over riding it (which will probably lead to poor trades). In order to trust an algo you probably have to understand it very well and you also have to be comfortable with somewhat passive statistical trading (but more intensive research and testing).


I think the advantages of algo trading far outweigh the disadvantages. But, some of the drawbacks are:

1) 98% of algos have a short lifespan. They work until they don’t and then you have to invest more time fixing them or creating the next one. It is a continuous process of monitoring, improvement and re-inventing.

2) users of algos can become complacent, sitting back and letting the ‘computer’ do the trading. That can lead to big losses, like the big algo trade that helped cause the flash crash in May 2010;

3) it takes a broad range of capabilities to create an algo trading operation, e.g. significant trading experience, knowledge of market data and micro-structure, ability to set up the necessary computer hardware, software and network, strategy conception and definition, programming skills, risk management, business management and of course capital. If you don’t possess all these yourself, you have to pay third parties to supply the missing pieces.


Thank you all I have been enlightened please keep me informed about all the developments in this area



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