What Is Algorithmic Trading?
Algorithmic trading is a method of buying and selling securities in which a computer program decides when to trade, what to trade, and how much, based on a set of instructions written in advance. The instructions, often called an algorithm, can be as simple as buying a stock when its moving average crosses above a certain level, or as complex as splitting a large order into many small pieces to limit its effect on the market.
Algorithmic trading is used by large institutions such as market makers and hedge funds, but it is also available to individual investors through many brokerage platforms and trading software.
How It Works
A typical algorithmic system has three parts: a data feed that supplies prices and other market information, a strategy that turns that data into trading signals, and an execution component that sends orders to the market. The rules can be based on price patterns, trading volume, timing, or statistical relationships between related securities. Once running, the program monitors conditions continuously and acts without waiting for a person to click a button.
Programs are usually tested first using backtesting, which runs the rules against historical data to see how they would have performed. Backtests can be misleading, however, because past data may not reflect future conditions and because it is easy to fit rules too closely to what has already happened.
Advantages and Disadvantages
Supporters point to speed, consistency, and discipline. A program applies the same rules every time, does not act on fear or excitement, and can process many markets at once. Automated execution can also reduce slippage, the gap between the expected price of a trade and the price actually received, when orders are sized and timed carefully.
The drawbacks are real. Programs can malfunction, sometimes quickly. A flawed rule can repeat losing trades at high speed, and a sudden market move can produce results the designers never anticipated. Strategies that once worked may stop working as other participants discover similar patterns. Building and maintaining these systems also requires programming skills, data, and infrastructure.
Why It Matters to Investors
Algorithmic trading accounts for a large share of activity in many markets, so it can influence prices, spreads, and liquidity. For individual investors, understanding it helps explain why prices sometimes move sharply in very short periods. It also highlights the importance of understanding how an order is executed, not just what is bought or sold. Algorithmic trading is a tool, and like any tool its results depend on the quality of its design and the conditions it encounters.
Updated October 15, 2026. For general education only; not financial, tax or legal advice.