What is Algorithmic Trading?

By Julie Mendel, Senior Product Manager
Oct 23, 2019
what is algorithmic trading

Algorithmic trading (a/k/a automated trading, black-box trading, or algo-trading) involves the use of an algorithm in a computer program to place a trade. The theory behind the popularity of this trading method is that an algorithmic trade will be able to generate profits and trades at a speed that a human trader can never achieve. 

Algorithmic trading strategies, including high frequency trading, are becoming prevalent in U.S. securities markets.  As these strategies become more popular, the adverse impact on the market and the potential for creating firm instability as a result have also grown. 

As a result, FINRA reminds firms engaging in algorithmic strategies of their compliance obligations under SEC and FINRA rules, with a focus on supervision.   While FINRA recognizes that a supervision and control program might not prevent every possible failure, they offer insight into several supervision and control practices that can be adopted to mitigate future problems.  The recommended supervisory and control practices include: 

  • FINRA recommends that firms adopt a general risk assessment and response plan.  This includes a holistic review of trading activity and implementation of a cross-disciplinary committee to assess and react to risks.

  • FINRA recommends that firms focus their efforts on the development software/codes for algorithmic strategies and focusing on testing of strategies and their implementation.

  • FINRA recommends that firms conduct software testing and system validation for all algorithmic strategies before they are put into production to assist with creating more effective policies and procedures.

  • FINRA recommends that firms develop policies and procedures that include a review of trading activity after an algorithmic strategy has been put in place or changed.

  • FINRA recommends that firms take steps to ensure there is effective communication between compliance staff and algorithmic strategy development staff as part of their overall policies and procedures.

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