Trading Glossary - Algorithmic Trading Terms

A

Algorithm

Fundamentals

A set of defined rules and instructions that a computer follows to execute trades automatically. Trading algorithms analyze market data, identify opportunities, and place orders without human intervention.

Algorithmic Trading

Fundamentals

A method of executing orders using automated, pre-programmed trading instructions that account for variables such as time, price, and volume. Also known as algo trading, automated trading, or black-box trading.

Alpha

Risk Metrics

A measure of an investment's performance compared to a benchmark index, representing the excess return. Positive alpha indicates outperformance; negative alpha indicates underperformance.

Example: An alpha of 2% means the investment returned 2% more than the benchmark would predict after adjusting for risk.

Arbitrage

Strategies

The practice of profiting from price differences of identical or similar financial instruments across different markets or forms. Pure arbitrage is risk-free; statistical arbitrage involves calculated risk.

Example: Buying a stock on one exchange for $100 and simultaneously selling it on another exchange for $100.50.

Ask Price

Market Structure

The lowest price at which a seller is willing to sell a security. Also called the offer price. The difference between the ask and bid price is the spread.

ATR (Average True Range)

Technical Indicators

A technical indicator that measures market volatility by calculating the average range between high and low prices over a specified period, accounting for gaps.

Example: A 14-day ATR of $2.50 means the stock has averaged $2.50 of daily price movement.

B

Backtesting

Strategy Development

The process of testing a trading strategy on historical data to evaluate how it would have performed in the past. Essential for validating strategies before live deployment.

Benchmark

Performance

A standard against which the performance of a security, mutual fund, or investment manager can be measured. Common benchmarks include the S&P 500 and Russell 2000.

Beta

Risk Metrics

A measure of an asset's volatility relative to the overall market. A beta of 1.0 means the asset moves with the market; greater than 1.0 means more volatile; less than 1.0 means less volatile.

Example: A stock with beta of 1.5 is expected to move 1.5% for every 1% move in the market.

Bid Price

Market Structure

The highest price a buyer is willing to pay for a security. Combined with the ask price, it forms the basis of market pricing.

Bollinger Bands

Technical Indicators

A technical indicator consisting of a middle band (usually 20-period SMA) and upper/lower bands set at 2 standard deviations above and below. Used to identify volatility and potential price reversals.

C

CAGR (Compound Annual Growth Rate)

Performance

The annualized average rate of return for an investment over a specified time period, assuming profits are reinvested. Useful for comparing returns across different time periods.

Example: An investment growing from $10,000 to $15,000 over 3 years has a CAGR of 14.5%.

Formula: CAGR = (Ending Value / Beginning Value)^(1/Years) - 1

Calmar Ratio

Risk Metrics

A risk-adjusted return metric that divides the compound annual growth rate by the maximum drawdown. Higher values indicate better risk-adjusted performance.

Formula: Calmar Ratio = CAGR / Maximum Drawdown

Cointegration

Statistics

A statistical property where two or more time series share a common stochastic trend, meaning their spread is mean-reverting. Essential for pairs trading strategies.

Correlation

Statistics

A statistical measure of how two securities move in relation to each other, ranging from -1 (perfect negative) to +1 (perfect positive). Zero indicates no relationship.

D

Day Order

Order Types

An order to buy or sell a security that automatically expires at the end of the trading day if not executed. The most common order duration type.

Drawdown

Risk Metrics

The peak-to-trough decline in portfolio value before a new peak is achieved. Expressed as a percentage of the peak value.

Example: If a portfolio rises to $100,000 then falls to $80,000, the drawdown is 20%.

E

EMA (Exponential Moving Average)

Technical Indicators

A type of moving average that gives more weight to recent prices, making it more responsive to new information than a simple moving average.

Execution

Trading

The completion of a buy or sell order for a security. Quality of execution considers price, speed, and the likelihood of completing the trade.

F

Fill

Trading

The completion of an order. A 'filled' order means the entire quantity has been bought or sold. A 'partial fill' means only some of the order was completed.

Fill or Kill (FOK)

Order Types

An order that must be executed immediately in its entirety or canceled completely. No partial fills are allowed.

G

Golden Cross

Technical Indicators

A bullish technical pattern where a shorter-term moving average (typically 50-day) crosses above a longer-term moving average (typically 200-day).

GTC (Good 'Til Canceled)

Order Types

An order that remains active until it is either executed or explicitly canceled by the trader. Brokers typically set maximum durations (e.g., 90 days).

H

High-Frequency Trading (HFT)

Strategies

A type of algorithmic trading characterized by high speeds, high turnover rates, and high order-to-trade ratios. Uses sophisticated algorithms to trade securities in milliseconds.

I

Immediate or Cancel (IOC)

Order Types

An order that must be executed immediately. Any portion that cannot be filled right away is automatically canceled.

In-Sample Data

Strategy Development

The portion of historical data used to develop and optimize a trading strategy. Should be separate from out-of-sample data used for validation.

K

Kelly Criterion

Risk Management

A mathematical formula for determining the optimal size of a series of bets to maximize long-term wealth growth. Commonly used in position sizing.

Formula: Kelly % = W - (L/R), where W=win rate, L=loss rate, R=win/loss ratio

L

Latency

Technology

The time delay between when a trading signal is generated and when the corresponding order is executed. Critical in high-frequency trading.

Limit Order

Order Types

An order to buy or sell a security at a specified price or better. Buy limits execute at the limit price or lower; sell limits execute at the limit price or higher.

Example: A buy limit order at $50 will only execute if the price is $50 or less.

Liquidity

Market Structure

The ease with which an asset can be bought or sold without significantly affecting its price. High liquidity means tight spreads and easy execution.

Long Position

Trading

Owning a security with the expectation that its price will rise. Profit is made when the security is sold at a higher price than the purchase price.

Look-Ahead Bias

Strategy Development

A backtesting error that occurs when a strategy uses information that would not have been available at the time the trading decision was made.

Example: Using tomorrow's opening price to make today's trading decision.

M

MACD (Moving Average Convergence Divergence)

Technical Indicators

A momentum indicator showing the relationship between two exponential moving averages (typically 12 and 26 periods). Includes a signal line (9-period EMA of MACD) and histogram.

Market Depth

Market Structure

The market's ability to absorb large orders without significantly impacting price. Measured by the number and size of orders at various price levels in the order book.

Market Order

Order Types

An order to buy or sell a security immediately at the best available current price. Guarantees execution but not price.

Maximum Drawdown

Risk Metrics

The largest peak-to-trough decline in portfolio value over a specific period. A key risk metric representing the worst-case scenario.

Example: A maximum drawdown of 25% means the portfolio lost 25% from its highest point before recovering.

Mean Reversion

Strategies

A trading strategy based on the theory that prices tend to return to their historical average over time. Traders buy below the mean and sell above it.

Momentum

Strategies

The rate of acceleration of a security's price movement. Momentum trading assumes that assets moving strongly in one direction will continue in that direction.

Moving Average

Technical Indicators

A technical indicator that smooths price data by calculating the average price over a specified number of periods. Helps identify trends and support/resistance levels.

O

Order Book

Market Structure

An electronic list of buy and sell orders for a specific security, organized by price level. Shows market depth and current bid/ask prices.

Out-of-Sample Data

Strategy Development

Historical data set aside for testing a strategy after it has been developed using in-sample data. Essential for validating strategy performance.

Overfitting

Strategy Development

The error of creating a trading strategy that is too closely tailored to historical data, capturing noise rather than genuine patterns. Leads to poor live performance.

P

Pairs Trading

Strategies

A market-neutral strategy that involves simultaneously buying an underperforming security and selling an outperforming correlated security, betting on convergence.

Paper Trading

Strategy Development

Simulated trading using virtual money to test strategies in real-time market conditions without risking actual capital. Also called demo trading.

Position Sizing

Risk Management

The process of determining how much capital to allocate to each trade, based on account size, risk tolerance, and strategy characteristics.

Profit Factor

Performance

A performance metric calculated by dividing gross profits by gross losses. A profit factor above 1.0 indicates a profitable strategy.

Example: A profit factor of 1.5 means the strategy earns $1.50 for every $1.00 lost.

Formula: Profit Factor = Gross Profits / Gross Losses

Q

Quantitative Trading

Fundamentals

Trading strategies that use mathematical and statistical models to identify opportunities. Often synonymous with algorithmic trading but emphasizes quantitative analysis.

R

Risk Management

The identification, assessment, and control of risks that could affect trading performance. Includes position sizing, stop losses, and diversification.

Risk-Reward Ratio

Risk Management

The potential profit of a trade compared to its potential loss. A 1:3 ratio means risking $1 to potentially make $3.

Example: Entering a trade with a $100 stop loss and $300 profit target has a 1:3 risk-reward ratio.

RSI (Relative Strength Index)

Technical Indicators

A momentum oscillator measuring the speed and magnitude of price changes, ranging from 0 to 100. Readings above 70 suggest overbought; below 30 suggest oversold.

S

Sharpe Ratio

Risk Metrics

A measure of risk-adjusted return, calculated as the portfolio's excess return over the risk-free rate divided by its standard deviation. Higher is better.

Example: A Sharpe ratio of 1.5 means the strategy generates 1.5 units of return per unit of risk.

Formula: Sharpe Ratio = (Return - Risk-Free Rate) / Standard Deviation

Short Position

Trading

Selling a borrowed security with the expectation that its price will fall, allowing repurchase at a lower price. Profit equals the price difference minus borrowing costs.

Slippage

Trading

The difference between the expected price of a trade and the actual execution price. Caused by market movement, low liquidity, or large order sizes.

Example: Placing a market buy order expecting $50 but executing at $50.05 results in $0.05 slippage.

SMA (Simple Moving Average)

Technical Indicators

A technical indicator calculated by taking the arithmetic mean of prices over a specified period. Each price point has equal weight.

Formula: SMA = (P1 + P2 + ... + Pn) / n

Sortino Ratio

Risk Metrics

A risk-adjusted return metric similar to the Sharpe Ratio but only penalizes downside volatility. Upside volatility is not considered negative.

Spread

Market Structure

The difference between the bid price (highest buy offer) and ask price (lowest sell offer) of a security. Tighter spreads indicate higher liquidity.

Standard Deviation

Statistics

A statistical measure of the dispersion of returns around the mean. Higher standard deviation indicates higher volatility and risk.

Statistical Arbitrage

Strategies

A trading strategy that uses statistical and mathematical models to identify and exploit pricing inefficiencies between related securities.

Stop Loss

Order Types

An order to sell a security when it reaches a specified price, designed to limit losses on a position. Essential for risk management.

Stop Order

Order Types

An order to buy or sell a security once it reaches a specified trigger price. When triggered, it becomes a market order.

Survivorship Bias

Strategy Development

A backtesting error that occurs when only currently existing securities are included in the analysis, ignoring those that have failed, merged, or been delisted.

Example: Testing a strategy only on current S&P 500 stocks ignores companies that were removed due to bankruptcy.

T

Take Profit

Order Types

An order to close a position when a specified profit target is reached. Locks in gains automatically when the target price is hit.

Technical Analysis

Fundamentals

A method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume. Based on the idea that history tends to repeat.

Trailing Stop

Order Types

A stop order that adjusts automatically as the price moves in a favorable direction, locking in profits while allowing for further gains.

Example: A 5% trailing stop on a stock at $100 triggers at $95, but if the stock rises to $120, the stop adjusts to $114.

Trend Following

Strategies

A trading strategy that attempts to capture gains by riding established market trends. Based on the assumption that prices trending in one direction will continue.

V

Volatility

Risk Metrics

A statistical measure of the dispersion of returns for a given security or market index. Higher volatility means larger price swings and typically higher risk.

Volume

Market Structure

The number of shares or contracts traded in a security or market during a given period. High volume often indicates strong interest and better liquidity.

VWAP (Volume Weighted Average Price)

Technical Indicators

The average price of a security weighted by volume over a specific period. Used as a benchmark for execution quality.

Formula: VWAP = Cumulative (Price × Volume) / Cumulative Volume

W

Walk-Forward Analysis

Strategy Development

A validation technique where a strategy is optimized on one data segment, tested on the next, then the window moves forward. Simulates real-world strategy deployment.

Win Rate

Performance

The percentage of trades that are profitable. Must be considered alongside average win/loss size to evaluate strategy effectiveness.

Formula: Win Rate = Winning Trades / Total Trades × 100

Z

Z-Score

Statistics

A statistical measurement describing a value's relationship to the mean of a group of values, measured in standard deviations. Used in mean reversion strategies.

Example: A z-score of 2.0 means the value is 2 standard deviations above the mean.

Formula: Z-Score = (Value - Mean) / Standard Deviation