Algorithmic trading is nothing but a pre-designed set of instructions programmed by the programmer to carry out a specific process. Many times the human investors and traders fail to handle numerous things while trading. It is the time when they feel the requirement of an intelligent algorithm or program.
Algo trading is gaining popularity among many big traders and clients. These mathematical programs monitor every price shift in the currency pair and help in trading forex effectively. They identify potential opportunities and turn this data into intelligent trading decisions. Moreover, compute-instructed trading also helps in reducing transaction costs and enables investment managers to gain control over their trading processes.
With the progression in technology, the number of traders using algorithmic trading is surging swiftly. Along with the surge in numbers, the algorithms themselves are turning more and more advanced.
In the forex market, there are a countless number of opinions available for the traders in the marketplace. It ranges from community-based automatic trading which you can implement and buy from many platforms to forex robot automatic trading which you can implement and buy directly.
Types of Forex Algorithmic Trading
There are four main types of Algo trading within the foreign exchange markets. These are as follows:
1) Auto-hedging: It is a technique which creates rules to mitigate exposure to risk for the trader.
2) Direct market access: It describes the lower costs and optimal speeds at which the Algo traders can connect and access several trading platforms
3) Statistical: It reflects an algorithmic technique which finds profitable trading opportunities depending on the mathematical and statistical analysis of the past time-series information.
4) Algorithmic execution strategies: It focuses on carrying out a pre-defined objective, including executing a trade swiftly or mitigate the market impact.
High-frequency trading is one of the subcategories of Algo trading. It is known for its extremely high speed and rate of the execution of trade orders. There are also significant benefits of high-frequency trading to traders which include trading within milliseconds of minor price shifts. However, it also carries some risks while trading in a volatile foreign exchange market.
Algorithmic Trading and Forex Market
Much of the surge in robotic trading in foreign exchange markets over the past few years have been because of programs automating several processes and mitigating the time needed to carry out forex market transactions. The efficiency produced by these programs results in cutting down the costs in executing these processes (such as trade orders execution). It is a fact that automating the process of trading has many advantages over manual executions. It includes benefits such as executing orders at the right time and setpoint, reduces monitoring time etc.
The banking institutions are also making use of these computer-based programs to update the currency pairs pieces on electronic platforms. Thus, it surges the speed of banks at which they can quote the market costs at the same time decreasing the total number of manual working hours for quoting prices.
Some banking institutions also make algorithms for mitigating their risk exposure. The programs are used to sell a certain currency to meet the client’s trade purchased by their bank for maintaining a fixed quantity of that specific currency. It enables the bank to sustain a pre-specified risk exposure level for holding the currency.
The benefit discussed above is not the only factor which is driving the level of growth in forex algorithmic trading. Automatic trading is also employed in speculative trading. The combination of high speed, ability to interpret information, ability to execute orders quickly has enabled traders to utilize arbitrage trading opportunities. Thus, resulting from small price shifts between various currency pairs.
In the forex market, the key methods for hedging certain trade is through currency options and spot contracts. Spot contracts refer to the sale or purchase of foreign currency with instant delivery. The spot forex market has risen significantly because of the introduction of algorithmic platforms. The rapid proliferation of data in the market costs leads to a rise in arbitrage opportunities.
Triangular arbitrage in the forex market refers to the process of converting a currency back into its original form by several different currencies. High frequency and algorithmic traders can only determine these opportunities through automated programs.
The forex options follow a similar method as an option on types of assets or securities in the derivatives market. The forex options allow the buyer the right to sell or buy the particular currency pair at a specific exchange rate at some pre-defined date in future. The computer algorithms use automatic binary options to hedge foreign currency trades. The outcome of the binary option can be any between two. The trade settles either at the predefined strike price or zero.
How do Algorithmic Trading works in the Forex Market?
After looking at the definition of algorithmic trading, its use in the forex market, let us move to another point of how algorithmic trading works in the forex market.
1) Trend Following or price action: This is one of the key motives for which traders use algorithmic trading. Analysts regard this as one of the most simple techniques. The trader can use it for comparing previous market trends and current market trends. The trader makes use of these outcomes to determine profitable market opportunities.
2) Arbitrage: Especially in Forex trading, robotic programs can be employed for determining the opportunity in several markets to use price differences. To apply these techniques, the trader requires two or more two forex broker accounts. After this, you can easily use the price differential between the two by using algorithmic trading.
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3) Forex Scalping: Forex scalping refers to an act of quickly moving in and out of various trading positions within a trading day. By this, traders aim at making a profit from the small price shift in the financial market. Algorithmic trading makes this process smooth and fast without any tension of continuously monitoring the trading screen.
Benefits of Algorithmic Trading in the Forex Market
Some of the benefits of algorithmic trading in the forex market are as follows:
1) Time Saving: Once you have set an algorithmic trading strategy, then there is no need to touch the trading screen frequently. You can sit back and relax, leaving things to work on their own. There is no need to monitor it. In this way, you can easily save valuable time. By eliminating the need to spend time on the computer screen and executing trades.
3) Better Trade Prices: Algo trading has shown better and faster results as far as trade prices are concerned in comparison to of manual trading. In short, we can say that it has the ability to generate a higher possibility for executing trade orders that too at your desired price level. All these are done through an automatic program set by the programmer.
2) No Emotion: Automatic trading is purely systematic. It is the computer programs which only follow the instructions precisely given by the trader. Thus it leaves no room for emotional decision-making and human error. Both these factors can cost you much while trading in the financial market.
Risks Involved with Algorithmic Trading in the Forex Market.
There are some drawbacks of algorithmic trading which can threaten the liquidity and stability of the forex market. One of the major drawbacks is related to the trading power imbalance. Some traders have the means to use sophisticated technology to get data and execute trade orders at a much faster speed in comparison to other traders. This imbalance in the automatic trading technology could result in fragmentation within the financial market and liquidity shortages with time.
Moreover, while there are primary differences between the forex market and stock market, it is a common belief that the similar high-frequency trading which intensified the stock market crash in the year 2010 could likewise affect the forex market. This automatic program might not be quick enough to respond. If the financial market goes through a drastic change because these are programmed for some specific market scenarios.
Markes require frequent monitoring, and thus the suspension of Algo trading is required in the scenario of a market crash or drastic changes. However, in such extreme conditions, a concurrent suspension of Algo trading by many market traders could result in a drastic decline in market liquidity and high volatility.
The Bottom Line
Algorithmic trading is successful in enhancing the efficiency and declining the charges of trading currency pairs. But it also comes along with added risk. For currency pairs to work precisely, they must be highly liquid and must be stable in terms of a store of value. Hence, the forex market must stay liquid with low price volatility.
Many traders are demanding greater transparency and regulation in the foreign exchange market. These are in terms of Algo trading-related concerns raised in the past. The increasing adoption of algorithmic trading in forex systems can efficiently surge transparency in the foreign exchange market. Some Algo trading strategies, including statistical analysis, auto hedging, high-frequency trading, direct market access, and algorithmic execution, can expose inconsistencies in price, which makes potential opportunities for investors.
However, the risk and problems that market members face in robotic trading will decrease in the future.