Algorithmic Trading In Forex
The world we live in has expanded exponentially onto the internet over the last 25 years. There simply isn’t an industry that hasn’t been impacted by the ferocity and explosiveness of the digital mushroom cloud the creation of the internet caused. As the impact of the digital world took hold, it began simultaneously creating and enhancing entire industries. One of these industries that benefitted was algorithmic trading. Whilst the rise of the internet hasn’t necessarily been the origin of algorithmic trading in Forex, advances in computing and computer programming have allowed this trading method to flourish. So I’m sure you’re wondering how algorithmic trading works and how to learn the basics.
Algorithmic Trading 101
Forex algorithmic trading strategies continue to be a popular method for all types of traders. This includes individual and institutional investors such as hedge funds, pensions, and investment banks. Although the idea was first conceived in the 1970s, it wasn’t until a decade later that program trading entered its initial stages of mass adoption.
Fast forwarding a few decades, the advances in computing have been incalculable. Algorithmic forex trading software is now an extremely competitive market. Is algorithmic trading profitable? Of course, plenty of investors make consistent returns from automated trading software. However, when looking for the best algorithmic trading software, some are better equipped to operate on multiple platforms.
A misconception in the past is that algorithmic forex trading software is only accessible to large hedge funds and investment banks. However, this isn’t the case.
As the technology has become increasingly sophisticated over the past 30 years, algorithmic trading in Forex has gone from a relative niche form of trading to widespread implementation, especially amongst institutional investors.
Using various methods, traders can execute limitless traders when their currency hits a specific buy or sell point. When it comes to asking questions such as “how much do algorithmic traders make?” it depends on various factors. If a trader uses larger amounts of capital, they will have more exposure but could gain a larger profit.
We must point out that even though algorithmic trading in Forex eliminates emotional trading and increases the chances of making a solid return due to extracting human error, it isn’t a guaranteed money printing technique.
Today, we’ll decipher which methods are more popular and may be best tailored to your trading technique. Ultimately, the goal of any trading strategy is to make money. When the stakes are high, and you’re trading with a considerable chunk of your net worth, emotion can play a part.
Arbitrage
The first strategy we’re going to explore today is arbitrage trading. Simply put, this strategy employs a technique whereby you buy on one exchange and sell on another, taking advantage of extremely small price differentials. The upside to arbitrage trading is that if you spot an opportunity and can execute it on time, it’s one of the most logical and sound ways to make profits in Forex. The likelihood is amplified by employing automated trading software, which constantly looks for these differences, removing the need to check different exchanges constantly.
Of course, there are some negatives to take into consideration as well. Cryptocurrency sees people taking advantage of arbitrage trading more successfully than forex trading. This is because forex trading has more established markets and has been around a lot longer, so it has better regulations and smaller margins of error.
The most spectacular example of arbitrage trading is that of Sam Bankman-Fried. Sam spotted price differentials in Bitcoin in US Dollars and Japanese Yen. Algorithmic trading explained how Sam was able to transfer these assets and take advantage of the price.
Over 3 years, Sam made billions of dollars. Forex price differences operated within much finer margins, so you’d need serious capital to make decent profits.
You may ask yourself, “is algorithmic trading legal?” – that’s a fair question considering Sam’s method seemed like a magic money tree. He took a considerable risk with each trade due to the network of financial avenues he had to use and to change the currencies so frequently. This was a sophisticated strategy that paid off massively for Sam. So in answer to the question, yes, it is perfectly legal and widespread.
However, following recent developments following the implosion of FTX, Sam Bankman-Fried, as the CEO, has come under intense scrutiny for his role in the collapse and has been arrested for how he handled the exchange and its subsequent collapse.
Triangular arbitrage operates with the same underlying methods but involves an additional currency pair. This method is not as well known or renowned but can still garner results if executed correctly. Algorithmic trading forex has become a much more attractive proposition.
Trend Following
In addition, another key factor of trend following involves comparing data, be it current market data or information dating back several months. Examining the statistics gives a better indicator of whether or not the market will move in a specific way.
However, as with any algorithmic forex trading software, other market factors cause the charts not to align with historical data trends. You want to ensure that the algorithmic forex trading you’re using is a highly rated and trustworthy.
Trading Range
Trading range is another popular form of algorithmic forex trading. Also known as mean reversion strategy. The premise of the trading range is that all assets have a normal price in standard circumstances called the “mean value”. This price periodically increases and decreases but eventually reverts to the mean value at some point. Some traders and analysts also call it a ‘natural price’ when discussing it.
You can capitalise on trading forex by assigning a price range for the average value and assigning place orders when this value moves out of range to mitigate risk. Market volatility and a range of other factors affect the price of a currency. Ultimately, there will be a level the currency has generally operated on over the past 6 to 12 months. If you find a point in the chart that falls below the mean price and you’re confident it will reach it again, this is a prime example of using trading range effectively.
Types of Algorithmic Trading
Auto-hedging is the first type of algorithmic trading in Forex we will look at today. This type of trading is risk-averse and is good practice. It consists of placing some of your investment in a position opposite your main investment. The idea behind this strategy is that you aren’t overleveraged into one position. You are then better suited to take a hit in unexpected market activity.
This isn’t the main reason people auto-hedge. It is one of the best practices to employ to ensure you have a balanced and diversified portfolio. A lopsided portfolio is not recommended; the same applies to your trading strategy. If you are completely set on one sole outcome, you are not covered if the trade does not materialise as you expected.
The second type of algorithmic trading we will explore is “statistical”. We have discussed some of the strategies we examined earlier in the article. Examining the charts and taking an educated gamble on where you think it could head is the essence of statistical trading. Trend following is an example of statistical reading.
The third and final type of algorithmic forex trading we will look at today is DMA (Direct Market Access). Forex trading has historically involved a brokerage acting as a middleman. The brokerage would then obtain quotes from the exchange and disclose the optimum price to the trader. DMA changed this approach. A DMA is an electronic trading instrument that allows you to view the various orders on the market. This includes buying orders and selling orders. You can then base your strategy around these figures.
This is advantageous as having the ability to calculate when large buy or sell orders are set raises your awareness. It heightens your awareness of overall market conditions and gives you a better base to begin your trade. Identifying when a huge buy or sell order will occur can allow you to buy at your ideal price or sell at your optimum price.
There are other types of forex algorithmic trading, but these three take up the bulk of trading strategies. You can utilise other tools to your advantage when it comes to trading. Social media can help you look for trends and news. Some of this news may indicate whether or not a particular market is heading in a specific direction.
For example, if you anticipated that the mini-budget revealed in the UK at the end of September would cut tax for the highest earners and ramp up borrowing, you could have purchased USD with GBP. The value of GBP depreciated heavily against the dollar following the announcement. Several hedge funds and investment banks who anticipated this dip made some serious profits. Another example not related to Forex would be Elon Musk’s relentless tweeting about the cryptocurrency Dogecoin throughout 2021. This saw investors snowball into the cryptocurrency and caused the price to increase dramatically.
This is just one example, of course. Not all information on social media is a bonafide fact, surprisingly. However, it can be a good indicator if the right market analysts are making similar assumptions. They’ll usually provide a strong indicator of market intentions if they’re all pushing in the same direction. If they’re operating from a position of high capital, their opinion may carry more weight. However, it is also a good idea to seek a range of opinions before you enter a trade.
Conclusion
The beauty of algorithmic trading in Forex is that you can do your research. You can then allow an automated trading system to execute your trades whilst you go about your day. If executed properly, it can become a passive income stream and removes any emotion from your trading. Emotional trading is one of the most common mistakes beginners make. Any tool that effectively battles this is a force for good in the trading world.
