How Algorithms Are Shaping Futures Trading
MAR 20, 2018 02:37 AM
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How Algorithms Are Shaping Futures Trading

by Larry Alton
 
Algorithms have taken over the investing world. One recent estimate by JPMorgan claims that these days, just 10 percent of all trades on the market are done by humans picking stocks; the rest are directly or indirectly done by automated programs. These algorithms have already had a significant effect on market prices and investor behavior, including flash crashes that unfold as a result of algorithmic selloffs building from other algorithmic selloffs.
 
But what effect could these algorithms have on the future of futures trading?
 
Futures Trading in a Nutshell
 
In some ways, trading futures works like trading any other investment asset or security. There are specific platforms dedicated to futures trading, and many brokerage platforms allow futures trading as well. However, instead of buying or selling a commodity or security directly, futures trading allows users to place contracts, which dictate the buying or selling of a specific quantity of a specific asset for a predetermined price at a predetermined date in the future. For example, if an asset is currently trading for $50 and you think the price of the asset is going to fall significantly, you could place a contract to sell the asset for $45 in 3 months’ time. If the price falls to $35, you can still sell for $45, and make far more profit than you otherwise would.
 
Futures trading is often used to hedge risk, protecting investors against sharp price decreases or other unpredictable activity. They’re also used for speculation, allowing investors to place bets on where they think an asset will move in the future.
 
The Effects of Algorithmic Trading
 
Algorithmic trading comes in many different varieties, but it’s ultimately used to automate the process of buying and selling commodities and securities. Sometimes, these algorithms forecast momentum to predict price changes and act accordingly. Other times, they use combinations of company valuation and trader psychology to place bets.
 
In almost all cases, algorithms act without human intervention and engage in high-frequency trading. And because so many algorithms act on the same cues, it’s easy for them to produce a cascading effect that sends ripples through the market.
 
  • Volatility. First, the high-frequency trading done by algorithms makes the market much more volatile. There are big upturns and downturns as a result of prices being pushed around by high-frequency trading. This makes the market a bit riskier—or a bit more exciting—for futures traders, depending on who you ask. 
  • Regulations. Algorithmic trading is also inciting more trading regulation, in part because automated trading could have such a pronounced effect on the market (and therefore the economy at large). This could make it harder for futures traders to make trades or use algorithms to enhance their profitability. 
  • Liquidity. Algorithmic behavior is influenced by liquidity, and vice versa. During off hours, when liquidity is much lower, algorithms have more propensity to take action, and have far more influence over the price of different commodities and securities. Accordingly, more futures traders are sticking to trading during periods of high liquidity as a way to mitigate this volatility.  
  • Accessibility and appeal. Finally, algorithms are changing how investors see futures trading. For some investors, algorithms are the safest bet to guard against market changes; they see futures trading and other riskier strategies as obsolete. For others, algorithms make the game more exciting, and they’re more likely to jump head-first into high-frequency trades as a result. 
Will futures trading disappear? Almost certainly not. But trading algorithms have already forged a strong position for themselves, and it’s unlikely they’ll do anything but become more prominent in the years to come. If you’re planning on getting into futures trading, or if you’re already a futures trader wondering what’s in store for you next, you need to be aware of these effects, and adapt your strategy accordingly. 
 
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