07. Distinction between Two Types of Algorithms

Published at 1655171737.236422

An investment process always consists of two stages: making buy/sell decisions and executing these orders. Depending on applications, we can classify algorithms into two types: profit-seeking algorithms and execution algorithms.

Execution Algorithms 

As the name suggests, these algorithms are used in execution orders to take advantage of computer systems. It is used to optimize the trading price. These algorithms are for high-volume trading and aim to avoid market fluctuations.

Here are the common groups of execution algorithms:

  • Scheduled algorithm: POV, TWAP, VWAP;

  • Liquidity seeking algorithm;

  • Arrival price algorithm;

  • Dark strategy/liquidity aggregators;

  • Smart order router algorithm.

Profit-Seeking Algorithms

Over the development of financial markets, profit-seeking algorithms have become more and more diverse. These algorithms all have the same goals to determine which securities to buy or sell, when, and in what volume to maximize profits.

The rules of this group are unified throughout the process from decision-making to order execution. The computer system will automate this process without human intervention.

The ultimate goal of investing is to increase profits. Investors pay more attention to the profit-seeking algorithms than the execution algorithms. However, it’s not easy to find profitable algorithms among thousands of options and a complex changing market landscape. Therefore, in reality profit-seeking algorithms are still on a small scale though they get much attention. In contrast, the group of execution algorithms is less well-known but easier to implement and more stable. In fact, this group is often used on a large scale by investment funds and professional investors.

Note that in the following, referring to “trading algorithms” or “algorithms” without further explanation can be understood as referring to profit-seeking algorithms.