This is a strategy that looks for overnight gappers and bets on a continuation of this move. Let’s go over a few examples to clarify this.Ī classic momentum strategy is the so-called ‘gap and go’ strategy. The underlying assumption for such strategies is that price moves can hold their momentum for an extended period of time. Instead of betting on prices returning to some state, momentum strategies try to profit from a continuation of a certain move. Momentum strategies are pretty much the exact opposite of mean reversion strategies. Next up, let’s take a look at a different type of algorithmic trading strategy, namely momentum strategies. This means they often move in sync with each other. As you can see, these two securities are closely correlated.
The following graph shows the normalized price moves of the exchange-traded funds SPY and QQQ at the beginning of 2008. Let me give you a specific example to clarify this: This type of mean reversion strategy is known as pairs trading. Therefore, a popular alternative to just looking at one security is to look at multiple different securities and their correlation. This obviously is a very simple mean reversion strategy and likely won’t result in a desirable outcome. The simplest form of mean reversion would be to use one or multiple moving averages of the stock’s price and trade around the discrepancy between this average and the stock’s price. In other words, we expect next month’s move to be closer to the average. For example, if the market has a huge rally in one week, we might bet on that the market won’t rise as much next month. In mean reversion strategies, we try to apply this concept to stock prices. For instance, if you go out for a walk and see a very tall person, chances are high that the next person you see is shorter and thus closer to the mean. Regression to the mean is a widespread phenomenon that can be found in many fields besides trading. Mean reversion strategies are based on the assumption that stock prices will revert to their average price over time. Let’s start with one of the most commonly used algorithmic trading startegies, namely mean reversion strategies. If you are completely new to algorithmic trading, I recommend first checking out my introduction to algorithmic trading. Note that some of these strategies can and are also used by discretionary traders.
Here is a list of the top 6 algorithmic trading strategies that I will break down in this article. No matter, your risk tolerance, preferred time frame, and favorite asset class, there is a right strategy that is right for you. Besides improving your understanding, this should also help you decide what kind of algorithmic trading strategy you want to learn more about. To help gain a much deeper understanding of the world of quantitative trading, I want to give you an overview of all the different algorithmic trading strategies that exist. Especially for newcomers, this can be very intimidating. There are so many different approaches to developing your own algorithmic trading strategies. Diving into the world of algorithmic trading can be exciting and overwhelming at the same time.
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