How To Create a Trading Algorithm for Strategic Success

January 20, 2024


Retail traders are constantly exploring ways to gain and maintain an edge over the markets. One approach that has gained significant traction in recent years is the use of trading algorithms. More traders rely on these algorithms to make trading decisions and generate sustainable returns.

The success of these systems means that most traders now understand they need to learn how to create a trading algorithm. Creating a trading algorithm is a demanding process that requires technical proficiency, strategic planning, and the flexibility to keep pace with changing market dynamics.

As one of the top prop trading firms in California, Black Eagle Financial Group offers a platform that supports algorithmic trading. In this guide, we’ll cover everything you need to know about creating your trading algorithm.

What Is a Trading Algorithm?

A trading algorithm is a computer program that trades the markets based on pre-determined rules. The rules cover how the algorithm will enter and exit the market, how much risk to deploy on each trade, and more.

Industry players call using a trading algorithm by various names, including algo trading, black-box trading, or automated trading.

The Advantages of Using a Trading Algorithm

Some of the biggest advantages of using a trading algorithm include the following.

Speedy Trade Execution

Robust trading algorithms execute trades in milliseconds. They don’t just open the position; they also execute risk management parameters such as profit targets and loss limits.

Executing each of these components of a position can take a human up to three minutes, which is a lot of time in the highly volatile world of trading.

The low latency nature of trading algorithms also equates to better order placement. There’s a lower risk of slippage with an algorithm that executes in milliseconds compared to a human trader taking the same positions.

Unsurprisingly, many high-frequency trading (HFT) enthusiasts only use algorithms when creating their trading strategies.

Better Diversification Across Multiple Instruments

Trading multiple instruments with an algorithm often means switching back and forth across the charts of various instruments. This is hugely demanding, especially for traders looking at shorter timeframes.

A multi-instrument trading algorithm can simultaneously monitor the market conditions of different tradeable assets.

Reduced Risk of Human Error

Human traders are always at risk of being swayed by emotional and psychological factors, resulting in costly trading mistakes. Some of these mistakes include holding back on positions for fear of being wrong, closing out profitable positions too early, indiscriminate changing of trade sizes, and more.

A trading algorithm negates these risks. Therefore, algo traders are more likely to see the statistical edge of their trading strategy play out. This increases the chances of profitability.

Quality and Faster Backtesting

Past performances do not guarantee future results in the trading world. However, backtesting remains the only way to ascertain any trading strategy’s efficacy. With a trading algorithm, it’s easier to stimulate past performances over years or decades.

Manual backtests are less thorough and more prone to curve fitting. A trading algorithm can present the true state of a trading strategy without any embellishments over a short window.

How To Create a Trading Algorithm

Below are the various steps to creating a trading algorithm.

Determine Your Trading Strategy

Every trading algorithm needs a set of instructions to work with. These instructions are usually the crux of a trading strategy.

The strategy must specify the rules for entering and exiting a position, how to manage risks, technical and fundamental indicators to use, the instruments to trade, and more. Tailor your algorithm to the market; for example, algorithms designed for the stock markets may fail in the CFD environment.

Many experienced traders are guilty of discretionary trading from time to time. However, this approach will not work with algo trading. 

Determine Your Programming Language

Trading algorithms are computer programs. You need to know at least one programming language to create your algorithm. Otherwise, you may need to hire a third party for the project. Some of the most popular programming languages for creating an algorithm include Java, C++, R, and Python.

Many algo traders choose Python as their programming language because it’s more readable. It also has a wealth of libraries for quantitative analysis, including Pandas, NumPy, and TA-Lib.

Gather Market Data

You’ll need access to historical and real-time market data to backtest and execute your trading algorithm. Many brokers and financial data providers grant access to market data through APIs. Check with your existing broker to see what they offer.

Complete the Coding for Your Algorithm

The code for your algorithm must define trading signals, risk management, order execution protocols, and general portfolio management. Be sure to refer to your trading strategy at this stage.

Complete the Backtest

With your algorithm in place, complete your backtest using historical data to see your algorithm’s performance in previous market conditions. The results of these backtests can also show you where to improve your trading strategy. For example, you may find out that changing your profit targets or loss limits can significantly improve your strategy’s annualized returns.

However, it’s important to avoid overfitting, where you continue to tweak the algorithm to perform better in past conditions while negatively impacting its efficiency in real-time conditions.

Test the Algorithm in Simulated Market Conditions

The safest way to know how your algorithm will perform in real market conditions is through a virtual or demo trading account. The simulated environment will show you how your algo will perform in live conditions without any risk to your finances. The virtual trading stage is another window for possible adjustments to your trading system.

Move To Live Trading Using Real Capital

Once you’re confident about your algorithm’s performance in backtests and in the virtual trading environment, it’s time to test it with real capital. Start with the least capital possible and gradually increase it as confidence in the strategy increases.

Monitor and Optimize

While algo trading supports hands-free trading, you need to constantly check the algorithm’s performance in live trading conditions, making adjustments to further improve the algorithm’s profitability.

Keep a document of your strategy, the algorithm’s code, your performance, and any changes you make over time. You may need it for future analysis and improvements.

Embrace Algo Trading With Black Eagle Financial Group

Do you already know how to create a trading algorithm? Are you looking for a trading firm offering a robust trading environment and a deep liquidity pool to support your strategy? Black Eagle Financial Group is a top choice.

We offer unfettered access to the US equities and options markets. Selecting a trading platform that meets your needs is also straightforward.

For further discussions on our offerings, contact Black Eagle Financial Group toll-free at (833) 253-2453 or email us at [email protected] to get started.

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