Rational investors in an irrational market
Today, an estimated 85% of trading in the US stock market is driven by algorithms. While the cryptocurrency market is much newer than the traditional equity market, cryptocurrencies can be traded on online exchanges — most of which offer the ability to place orders via an API, allowing for algorithmic trading.
Simply put, “algorithmic trading” refers to using a computer program or system to trade on the market according to a specified set of rules. Algorithmic trading often makes use of mathematical models and formulas to decide when and how to trade assets on an exchange.
Cryptocurrency markets provide several advantages for algorithmic traders. First, cryptocurrency markets typically have much higher volatility than traditional markets, creating bigger swings in prices and opportunities for traders.
Cryptocurrency markets also are open for business 24/7, further expanding the universe of opportunities for automated trading.
Finally, algorithmic trading in traditional markets is dominated by proprietary strategies run by multibillion-dollar quant funds. Cryptocurrency markets are much younger, which means it’s relatively less saturated with massive funds.
Algorithmic trading can help traders determine when to trade by looking at anything from price, to momentum, to volume — and beyond. The advantage of algorithms is that they can act on these signals much faster than a human can.
Algorithmic trading can capitalize on arbitrage opportunities where the price of an asset on one exchange is different from the price of the asset on another exchange. Algorithms are able to rapidly sniff out these inefficiencies in the market and profit off of them — much faster than a human could.
While an algorithm can spot potential arbitrage opportunities across exchanges, turning a profit means that it has to take into account potential time delays in execution, liquidity across different exchanges, and fees charged by exchanges. In volatile times, though, these arbitrage opportunities can be larger and therefore relatively easier to capture.