If you think iceberging is sneaky, then the stealth strategy is even sneakier! In forex markets, currency pairs are traded in varying volumes according to quoted prices. This is why many beginners turn to Forex trading algorithms to help them out at the beginning.
Forex Market Basics
Today, technological advancements have transformed the forex market. Trades can be made quickly over your computer, allowing retail traders to enter the market, while real-time streaming prices have led to greater transparency , and the distinction between dealers and their most sophisticated customers has been minimized. Another significant change is the introduction of algorithmic trading , which may have lead to improvements to the functioning of forex trading, but also poses risks. In this article, we'll identify some advantages algorithmic trading has brought to currency trading by looking at the basics of the forex market and algorithmic trading while also pointing out some of its inherent risks.
In forex markets, currency pairs are traded in varying volumes according to quoted prices. A base currency is given a price in terms of a quote currency. The bulk of this trading is conducted in U. Activity in the forex market affects real exchange rates and can therefore profoundly influence the output, employment, inflation and capital flows of any particular nation.
For this reason, policymakers, the public and the media all have a vested interest in the forex market. An algorithm is essentially a set of specific rules designed to complete a defined task. In financial market trading, computers carry out user-defined algorithms characterized by a set of rules such as timing, price or quantity that determine trades.
There exist four basic types of algorithmic trading within financial markets:. One of the subcategories of algorithmic trading is high frequency trading, which is characterized by the extremely high rate and speed of trade order executions.
High-frequency trading can give significant advantages to traders, including the ability to make trades within milliseconds of incremental price changes , but also carry certain risks when trading in a volatile forex market. Much of the growth in algorithmic trading in forex markets over the past years has been due to algorithms automating certain processes and reducing the hours needed to conduct foreign exchange transactions.
The efficiency created by automation leads to lower costs in carrying out these processes , such as the execution of trade orders. Automating the trading process with an algorithm that trades based on predetermined criteria, such as executing orders over a specified period of time or at a specific price, is significantly more efficient than manual execution.
Banks have also taken advantage of algorithms that are programmed to update prices of currency pairs on electronic trading platforms. These algorithms increase the speed at which banks can quote market prices while simultaneously reducing the number of manual working hours it takes to quote prices.
Here are some of the most compelling: Algorithms are purely mathematical and eliminate pesky psychological flaws. Algorithms are calculated on the fly, giving you quick access to valuable information.
Algorithms are a terrific learning tool. If you're an inexperienced trader, or perhaps a veteran trying a new strategy, algorithms can help you jumpstart the process. Algorithms are automated, reducing any human error that could lead you to make a faulty decision. Strategies for Forex Algorithmic Trading A Forex trading algorithm will only be as successful as the logic and strategy it is based on.
Here are some of the most popular ways that profitable Forex traders use algorithms: Hedging is a strategy designed to protect your portfolio from significant, sudden losses. You can set algorithms that limit the amount of risk to which you expose yourself.
For example, you can set algorithms for spot contracts contracts that deliver immediately as defense against sudden drops in the value of your long-term currency plays. Algorithms can identify arbitrage opportunities, which are always profitable. On separate markets, currency pairs might be priced differently. If the difference between the two pairs covers your spread, you can immediately buy and sell the currency for a guaranteed profit.
One of the most important tools in an investor's toolbox is statistical analysis. Algorithms should be set to do complex statistical analysis for you, telling you exactly when the ideal time to buy or sell is.
High frequency trading is one of the most popular types of Forex trading algorithms. This is a strategy employed by large financial institutions who are very secretive about their forex positions. Instead of placing one huge long or short position with just one broker, they break up their trade into smaller positions and execute these under different brokers.
Their algorithm can even enable these smaller trade orders to be placed at different times to keep other market participants from finding out! This way, financial institutions are able to execute trades under normal market conditions without sudden price fluctuations.
If you think iceberging is sneaky, then the stealth strategy is even sneakier! Iceberging has been such a common practice in the past few years that hardcore market watchers were able to hack into this idea and come up with an algorithm to piece together these smaller orders and figure out if a large market player is behind all of it.
Do stay tuned for the next part of this series, as I plan to let you in on the latest developments and the future of algorithmic FX trading.
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