Common Financial Terms & Concepts

Quantitative Trading vs. Algorithmic Trading: What's the difference?

The process and experience of trading has changed drastically in the past few decades. Trading started in the form of outcry in an exchange building, then it came over the phone, then to computerised trading where you execute orders online and now today, where programs and automatic software trade on a global level in microseconds.

Today the words Algorithmic Trading and Quantitative Trading are often used frequently and traders/ financial Institutions believe that these are the new & better ways of trading. The majority of trades are executed by algo and quant trading only. So, let's understand what is Quantitative and Algorithmic Trading and what is the difference between the two.

Quantitative Trading: Meaning

Quantitative trading is the strategy for trading which uses mathematical functions to build models that can trade automatically. Main inputs to these mathematical models are price and volume as the quantity traded is generally large in size.

Traders basically pick a technique, create a model, develop a program and backtest it on historical data of the market. Then the model is optimised and implemented in real-time markets with real money.

Quantitaive Trading: Key points

  1. The objective is to automate monitoring, analysing, and trading decisions with increased probability of profits.
  2. It eliminates the emotional factor whether it is greed to earn more or fear of not losing more.
  3. As financial markets are dynamic in nature, quantitative trading has limited scope and it fails when market conditions change.

Algorithmic Trading: Meaning

Algo-trading focuses on the set of instructions provided by the trader and uses a computer program to execute trade in line with the instructions provided. The instructions can be related to price, quantity, timing, or any mathematical model.

The speed and frequency with which algo trading works, it can not be matched by a human. Again, it cuts human emotions and makes things systematic.

Algorithmic Trading: Key Points

  1. Trades are executed instantly, accurately and at the desired level.
  2. Algorithmic trading strategy can also be backtested with historical or real-time data.

Quantitative Trading vs. Algorithm Trading: What is the difference?

Quant Trading uses advanced mathematical and statistical models to develop trading strategies. It also includes conducting research and analyzing historical data for finding trading opportunities to make profit. It is mostly used by financial institutions and hedge funds. Once the strategy is built, trades can be executed automatically or manually.

Algo Trading is the subset of Quant trading that uses a pre-programmed algorithm. The algorithm focuses on various aspects like price, quantity, timing, and automatically executes the trade without human intervention. The whole process is automated from order generation to order execution. Algorithmic Trading is generally used by large institutional investors like mutual funds and hedge funds.

Common algo trading strategies are Trend-following Strategies, Arbitrage Opportunities, Index Fund Rebalancing, Mathematical Model-based Strategies, Trading Range (Mean Reversion), Volume-weighted Average Price (VWAP), Time Weighted Average Price (TWAP), Percentage of Volume (POV) and Implementation Shortfall.

While quant trading also includes Statistical Arbitrage and High-Frequency Trading apart from Algorithmic Trading.

Whether you are from a technical background or not, you must learn and practice these strategies for faster & better execution, reduce impact cost, avoid errors, reduce emotions. Most importantly, induce more discipline to earn more profits with calculative risks through these trading models.

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