Algorithm - Financial definition
Concise definition of the term algorithm
An algorithm is a step-by-step procedure or formula for solving a problem or completing a task. It is a finite sequence of well-defined instructions typically used for data processing, calculation, and automated reasoning.
Comprehensive definition of the term algorithm
In the financial context, algorithms are pivotal for automated trading, often referred to as algorithmic trading or algo-trading. These sophisticated algorithms can process vast amounts of market data at high speeds to identify and exploit trading opportunities, execute trades at the best possible prices, and manage risk. Practical examples include high-frequency trading (HFT), where algorithms execute numerous trades within microseconds, and portfolio optimization strategies that adjust asset allocations based on market conditions. Market practices such as backtesting, where algorithms are tested against historical data to validate their effectiveness, and the use of machine learning to enhance predictive capabilities, further underscore the integral role of algorithms in modern finance.