Understanding Execution Systems in Quantitative Trading
Execution systems are at the heart of transforming a backtested trading strategy into reality. Whether you’re building a semi-automated or a fully automated setup, the goal is the same: efficient, timely, and cost-effective execution of trades to achieve the results your models have promised. Let’s dive into the basics of execution systems, explore the differences between manual, semi-automated, and fully automated systems, and look at how they can influence your trading outcomes.
What Are Execution Systems?
An execution system is the technological backbone that takes trading signals generated by your strategy and turns them into real-world orders. It connects to your brokerage, retrieves the market data, processes your trading algorithms, and finally submits orders for execution. There are two main types of execution systems: semi-automated and fully automated.
Semi-Automated vs. Fully Automated Systems
Semi-Automated Trading Systems
A semi-automated trading system involves some degree of manual interaction. Typically, traders generate an order list through software like Excel, MATLAB, Python, or R. This order list might be the output of a backtest program using updated data, and the trader would upload this list to their broker’s platform—such as a basket trader or spread trader. The order submission still requires human action, such as pressing a button to execute orders.
The benefits of a semi-automated system include:
- Flexibility: The trader retains manual control, allowing a final sanity check before orders are placed.
- Simplicity: Building a semi-automated setup is often easier, and doesn’t require the same depth of programming skills.
However, the downside is that human intervention can introduce delays and errors, which can reduce profitability, especially for time-sensitive trades.
Fully Automated Trading Systems
Fully automated trading systems take automation a step further. From the retrieval of market data to the submission of orders, everything is done without manual intervention. The process is run in a loop, continuously scanning the latest prices, running algorithms, and transmitting new orders as conditions evolve throughout the trading day. This type of system is often essential for high-frequency trading, where even milliseconds can make a significant difference.
Fully automated systems are beneficial because they:
- Eliminate Human Error: By removing the need for manual input, the system can avoid human mistakes or judgment errors.
- Speed Up Execution: Orders can be generated and submitted faster than in a semi-automated setup, crucial for high-frequency strategies.
- Scalability: They allow the execution of multiple strategies at the same time without additional human resource overhead.
Building Your Execution System
Building a semi-automated system often means generating orders in a familiar environment like Excel, and then uploading them through tools provided by brokers, like basket traders. Fully automated systems, on the other hand, require integration with APIs provided by brokerages or using trading platforms like QuantConnect, OpenAlgo or Blueshift, which simplify the connection between your strategy and your broker.
In fully automated setups, languages like Python, C++, or C# are often used, and the system’s design revolves around minimizing latency and ensuring seamless connectivity between market data streams, algorithms, and order placement.
Minimizing Transaction Costs
A critical part of execution is managing transaction costs. Automated systems help by minimizing delays and slippage, but you should also consider factors like order size relative to average trading volume. For example, keeping your orders below 1% of average daily trading volume can help reduce market impact. For larger trades, breaking them into smaller chunks or employing algorithms that gradually submit orders may reduce market impact but could increase slippage.
Testing Your System with Paper Trading, Dry Run, or Minimal Funds
Before going live, always run a paper trading phase, a dry run, or use minimal funds. Paper trading, using a broker’s simulation account, allows you to evaluate the effectiveness of your execution system, catch software bugs, and understand operational hurdles without risking capital. Importantly, paper trading gives you an insight into the divergence between theoretical and live performance, helping to refine the setup to be more aligned with reality.
Key Takeaways
- Semi-Automated vs. Fully Automated: Semi-automated systems allow for human oversight, while fully automated systems offer the speed and efficiency necessary for high-frequency trading.
- Reducing Costs: Transaction costs and market impact can be minimized by carefully managing order size and frequency.
- Test Before You Trade: Use paper trading, a dry run, or minimal funds to identify bugs, operational challenges, and to align your expectations with real-world outcomes.
In a world where efficiency can mean the difference between profit and loss, having the right execution system can make all the difference. Whether you choose a semi-automated or a fully automated approach, understanding how these systems work and how to optimize them will put you in the best position to succeed in quantitative trading.
