The foreign exchange market is one of the world's largest and most liquid marketplaces, with several best online trading platforms to choose from. The daily transaction volume approaches 5 trillion dollars per day, with various currencies being traded simultaneously. It should come as no surprise that algorithmic trading has found an established home within the forex market.
How do algorithmic Forex strategies differ from others?
Algorithmic Forex strategies are distinct from their counterparts in other markets in several unique ways:
First, competition among hedge funds and other institutional participants is less intense despite rapid adoption amongst retail traders. It leads to tighter spreads and higher liquidity than more mature markets such as US equities or commodities. Because of the relatively relaxed nature of the marketplace here, algorithmic strategies can be both easier to launch and more consistent.
Second, leverage is available from brokers on a per-trade basis - which makes leveraging an algorithmic strategy—no need to obtain financing from your prime broker for your entire portfolio. In fact, since most algorithm strategies trade in smaller lot sizes (i.e., micro lots), they are often better off not using any leverage at all. It reduces their continued exposure or the risk that spreads widen over time.
Third, restrictions imposed by Regulation T do not apply in this market! That means no maintenance margin requirement and no mandatory 10% full day trading restriction. You can trade all you want when you want, subject only to slippage against your limit orders and spread/liquidity considerations.
Finally, the nature of algorithmic trading inherently allows for better risk management and hedging. Since you can adjust down market exposure to a single trade (or even smaller units such as micro lots), the size of your exposure is determined mainly by how much capital you have at your disposal. Exposure can be managed precisely, allowing for more fine-tuned adjustments in times of high volatility.
Algorithmic strategies are well-equipped to weather tougher conditions than other types of automated trading. It should hardly come as a surprise that so many retail forex traders prefer these techniques to manually-implemented strategies.
Why are algorithmic Forex strategies essential?
For most traders, automated trading provides a way to overcome one of the significant challenges involved in forex trading: the ability to decide when to enter and exit trades. An algorithm can be written that makes this decision for them, focusing on other essential aspects of their trade plan, such as money management.
What are the risks associated with Algorithmic Forex strategies?
If you are considering investing in algorithmic forex strategies, the risks should be your first concern. The most common types of algorithmic Forex strategies involve quantitative analysis, and the two main methods used today are artificial neural networks (ANN) and genetic programming (GP).
Here's a list of the main risks associated with algorithmic Forex strategies:
Programming errors
This problem is most common when high-frequency trading systems are being used as they require many different signals for actions to be taken. In addition, you will only identify any coding errors once the system has gone live, and all trades based on that code will then be incorrectly executed.
Human intervention
If your algorithm is designed to take action without human oversight, then you could find yourself incurring unexpected losses very quickly if it malfunctions.
System overload/over-trading
Suppose your system is buying and selling currencies at a very high frequency. In that case, you could find yourself incurring unnecessary transaction costs as well as running out of capital too quickly if your initial trading positions are not successful.
Latency
Latency usually affects electronic trading systems, particularly high-frequency trading algorithms. However, it can also affect algorithmic Forex strategies if they are overly reliant on data feeds that must be interpolated or extrapolated before action is taken.
Conclusion
By taking advantage of algorithmic forex strategies, people can manage their accounts and portfolios for maximum profitability while still retaining some level of flexibility and control over the automated algorithms they use for forex analysis. New forex traders are advised to make use of brokers for forex trading to help them get started.
