Algorithmic trading means letting software place and manage trades according to rules you have defined in advance. That is all it means. It does not mean the software knows where the market is going.
A strategy as a set of rules
Every algorithmic strategy answers the same questions explicitly: what conditions must be true to enter, how large the position should be, where the protective stop goes, and what ends the trade. A manual trader answers them too, but often differently from one day to the next. The algorithm answers them the same way every time.
What it does well
- Consistency. The rules are applied without fatigue, hesitation or revenge trading.
- Coverage. Software can watch several markets through every session.
- Testability. Precise rules can be run against historical data before real money is involved.
- Reviewability. Every decision can be logged with its reason.
What it does not do
An algorithm executes a strategy; it does not make a weak strategy strong. Rules fitted too closely to past data often fail on new data. Markets change character, and a trend-following system will lose in a range. Execution matters as well: spreads widen, orders slip and connections drop.
Back-tests deserve particular caution. They are built with hindsight, usually assume ideal fills, and say nothing certain about the future.
A sensible way to start
- Write your rules down until nothing is left to interpretation.
- Test on historical data, then on a demo account.
- Set risk limits before you set profit targets.
- Start small, and read the log.