It had always been a misconception, especially for hedge funds in Vietnam, to equate algorithmic trading with superior return. In fact, this is not true. In finance, if it is not about return then what is it about? This article aims to make it clear what benefits algorithmic trading offers to institutional investors in their own perspective as well as the domain that algorithmic trading can’t offer.

What Algorithmic Trading Can Offer

1. Cost optimization. This should be the first sure thing after one firm successfully transitions to algorithmic trading. With a fully automated system, any task that is repetitive will be automated. Some standard tasks such as order execution, portfolio management, reporting and account management can be fully automated in any firm. Also, by deploying execution algorithms, hedge funds may reduce the cost when trading in large volumes. In some special cases such as passive funds, a full system can be automated with execution algorithms to optimize the management cost at an average of 0.12% in the US in comparison to more than 1% in the Vietnam market. That is a ten-fold difference. Hence, there is a vast opportunity for hedge funds to optimize cost to increase competency in the financial market.  

2. Improve Stability. Without emotion, a computerized system will not misbehave in 99.99% of cases that will absolutely enhance system stability. It is common sense that the more people involved, the more complex the system, the easier it is to have some problems elsewhere. To some extent, especially in the finance industry, where information is vital, it will be very costly to control internal risk. Thus, an automated system will reduce those risks and improve stability. 

3. Access To New Research Domain. There are some approaches that only automated systems can explore based on their speed and consistency such as:

• Market-Making: Require thousands of orders daily with heavy calculation. That should exceed the capacity of any individual.

• Scalping: Calculate the chance of winning every new tick which means approximately 30 complex calculations in each minute.

• Market Neutral: Calculate every new tick and simultaneously open positions in different financial instructions when receiving signals. 

Thus, algorithmic trading does offer access to new research domains that a merely “talented” human can’t do. 

What Algorithmic Trading Can’t Offer

1. Guarantee superior return. Algorithmic trading can provide certain advantages, but it does not guarantee superior returns. Algorithmic trading is in essence an automated system with predefined rules after a very thoroughly backtesting process. Algorithmic traders always try to improve the confidence level of an algorithm before going to production. Even working in such an attitude, the financial landscape will always change and many of the factors which have high impact will never be under control of an algorithm. Such factors can be named such as: geopolitical, war, pandemic, natural disaster. Thus, a guaranteed superior return may not hold true, especially for large firms. 

2. Macro trend. This task is highly sensitive within the industry and requires in-depth knowledge of macroeconomic structures in relation to geopolitical developments. Analyzing macro numbers is possible for algorithmic trading although combining this information with the movement of geopolitics is not in the scope of algorithmic trading. 

3. Collect unique information. Collecting non-standard and non-public data that will likely have a strong impact on the market is a domain beyond the reach of algorithmic trading. This unique competitive edge depends on industry experts with a lot of close connections. In the Vietnam stock market, which is a frontier market as of 2024, the more unique information one hedge fund manager has, the better chance of staying competitive in the market.  

In conclusion, algorithmic trading does offer some important advantages for a typical hedge fund but it is not a magical tool for superior return. Also, it is not capable of accomplishing some important tasks that only humans can achieve. To adopt algorithmic trading, the one strategy that aligns the most between the two domains is high latency predefined rules algorithms such as smart beta strategy.