Understanding the Basics of Forex Algorithmic Trading

Forex Algorithmic Trading 101

Forex trading is quickly settling in among most folks, thanks to the ever-growing technological advancements. In the past, trading forex was merely over institutional investors or over telephones and other ways that made it difficult for retail traders.

However, trades are quicker (we should rather say smarter) today as the computers have made the process better and transparent. Moreover, the introduction of algorithmic trading is another significant change which has massively improved forex trading.

But, how much do you understand algorithmic trading?

What is Algorithm Trading anyway?

When new to trading, several things will be crossing the mind, but it’s very much unlikely that algo trading can be amongst them. However, they’re a very significant and useful part of successful trading.

Some perceive algo trading as a complex area, but it’s indeed a reasonably straightforward concept. It’s a more technical means of referring to an automated form of trading. They’re a set of rules that a computer program follows in solving a particular problem.

Algo trading has got some of its advantages as well as some inherent risks. Therefore, the time is now right to understand the basics of Algo trading and the general forex market.

Forex Market Basics

Forex trading is merely the globes’ most enormous as well as liquid financial market that trades 24 hours and five days a week. It’s merely the buying/selling currency for another. Businesses, people, and countries participate all in it with the bulk of the trading conducted in euros, US dollars, and Japanese Yen.

In 2017, the daily global average volume was about $3 trillion for forex trading. Forex trading is gaining more momentum with several people now getting involved.

Algorithmic Trading Basics

Algo trading, in theory, may produce profits at speed as well frequency, which is impossible for an ordinary human trader. The set instructions are based on price, timing, quantity, or some mathematical model.

Moreover, algo trading renders the market more liquid as well as trading systematically ruling out the impact of emotions by a trader on trading activities.

Within the financial markets, there’re four basic types of algo trading which include;

  1. Statistical – This is an algo strategy that seeks profitable trading opportunities via statistical analysis of the past time-series data.
  2. Algo execution strategies – This is a type that aims in executing a predefined objective like reducing a market impact or executing a trade faster.
  3. Auto-hedging – It’s a means that generates the rules that reduce the trader’s exposure to the risk.
  4. Direct market access – This strategy describes optimal speeds as well as lower costs whereby traders access and connect to the multiple trading platforms.

Also, algo trading involves high-frequency trading (HFT), which has a high rate as well as the speed of order executions. Moreover, it gives a trader the ability to make a trade just in milliseconds.

When trading, it takes time to manually look for a suitable trade to execute by filtering through data. Maybe, by the time you’re ready to press that button to execute, the conditions may have shifted. Therefore, an algorithm comes into play to get things done instantly.

But, can anyone make an algorithm?

Well, yes and no. Most platform nowadays has made it easier to create an algorithm, or at the very least, custom indicators. However, creating complex algorithms require some particular skill in the field.

Benefits of Algorithmic Trading

Algo trading has the following benefits;

  • Trades executed at best possible prices
  • Reduced transaction costs
  • Instant and accurate trade order placement
  • Reduced risk for manual errors
  • Automated checks are simultaneous for multiple market conditions
  • It can be backtested for viability

Algorithm Trading Risks

As much algorithm trading does a lot of advantages, it does come with some downsides. For instance, the imbalances in the trading power of the market participants. Some folks have the technical ability to acquire high tech to execute orders faster than others. Therefore, it may lead to fragmentation in the market, and over time, it may result in liquidity shortages.

Nevertheless, algo trading has increased efficiency and reduced costs for trading forex despite its risks. One thing, however, to note is that the more complex an algorithm is the more stringent backtesting is required before being put into action.