Systematic Trading vs. Algorithmic Trading

Many people view systematic trading and algorithmic trading as one and the same. While it is true, in the sense that all algorithmic trading is systematic, the reverse is not true. Some key differences between the two are worth noting. Here's a quick rundown of each type of trading and how they differ.

Systematic Trading

Systematic trading is a method of trading that relies on a strict set of rules to generate buy and sell signals. These rules are based on factors such as price, volume, indicators, and also fundamental factors. Systematic traders will typically use computer-based models to make their decisions, but some may also use manual methods. The execution of the trades based on these rules can be done manually or in an automated way. The former is more common with systematic traders.

Algorithmic Trading

Algorithmic trading is a type of trading that uses computer algorithms to make trading decisions. These algorithms take into account a variety of factors, including market conditions, order types, and timing. Algorithmic traders use automated systems to execute their trades.

Differences Between Systematic and Algorithmic Trading

The main difference between systematic and algorithmic trading is the amount of discretion involved. Systematic traders rely heavily on their rules-based system to make decisions, while algorithmic traders give their algorithms more leeway to make decisions based on market conditions - often called black-box trading.

Another key difference is the level of automation. Systematic traders may use some automation, but they still have the ability to override their system if they see fit. Algorithmic traders, on the other hand, typically rely entirely on their automated system to make trades.

Finally, systematic traders tend to focus more on mid-term and longer-term trends, while algorithmic traders often seek to take advantage of very short-term to shorter-term opportunities. One of the common applications of algorithmic trading is in high-frequency trading (HFT), commonly used by large financial institutions and hedge funds, which would hold positions for seconds or minutes.

Basically, Algorithmic Trading is a more advanced form of Systematic Trading.

Systematic Trading is better for beginners

Many beginner traders are drawn to algorithmic trading because it seems a quick and easy way to make money in the markets. But this lure almost always turns out poorly. There are many challenges with algorithmic trading.

  1. Requires proper design of algorithms and execution systems. Since these are automated, any flaw in coding can lead to big losses. Also, there needs to be proper failover and failsafe creation to handle any technical glitch that can happen anywhere in the entire trading network.
  2. Also, algorithms cannot handle anomalous events, also known as black swan events, well enough. An example of this is the 2010 flash crash.  This, again, can cause big losses.
  3. Giving too much leeway to algorithms, especially in the black box trading systems, can be dangerous as one lacks very little control over the algorithmic interpretation of various events and the corresponding execution. Sometimes human override is needed as algorithms are not yet fully capable dynamic range of human thought processes - especially those used by retail traders.
  4. Algorithmic trading is a lot more expensive in practice operationally.
  5. There are lot of regulatory requirements and compliance that one need to take care of before deploying algorithmic trading systems.

As such, for beginners, the systematic approach of building setup, entry and exit rules, testing it against historical data, simulated data, and then on real-time market data to build confidence but managing the execution manually so that one completely understands why a decision is made is a better way to learn, build confidence, and stay safe in the market.


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