Forex algorithmic trading, or trading by algorithm, is the process of executing trades using computer programs to analyze data and execute orders in the forex market. Algorithmic traders rely on quantitative methods such as technical analysis for their decision-making.
Algorithmic trading is simply the use of software and computers to make trades on your behalf for certain market conditions; we call this algorithmic or automated trading. You will find that algorithmic strategies vary from basic entry and exit rules to more complex models, such as advanced statistical derivatives like value at risk (VaR) and optimal f portfolios (OFP). So why would you want to let an algorithm do the work for you? The three main reasons are speed, accuracy and potential profitability.
Speed – Usingautomated strategies are fast, and I mean fast! We can process and execute trades on a scale of milliseconds. Humans cannot compete with the speed at which computers operate.
Accuracy – If you have done any trading before, you will know that we as humans are biased by our emotions, and we make mistakes. So how do you think it feels when an algorithm makes a mistake? It doesn’t, as it does not have feelings or emotions; therefore, algorithms typically reduce your trading errors.
Profitability – Algorithmic strategies often outperform the market averages because they follow simple rules to generate entry/exit signals from highly liquid instruments such as forex, indices and stocks.
3 different types of algorithmic trading strategies
The first is basic entry/exit rules, where the focus is on getting you into a trade quickly and then following up with an exit rule to take your profits or cut your losses. These rules require little programming knowledge, but they need to be tested thoroughly before being used in live trading. You can backtest them by running historical data until you find good entry/exit points that work well in different market conditions.
Another type of algorithmic strategy is called Pairs Trading, which can generate huge returns using strategies such as statistical arbitrage, volatility, trend following, or mean reversion algorithms. This is where it gets fun! Statistical arbitrage pairs are found by looking at price correlations between multiple financial instruments, for example, EUR/USD vs AUD/USD. You can then identify trends and position yourself to take advantage of these correlations for more predictive results or use volatility algorithms that trade the expectation of significant price changes for minimal risk.
The third type is called automated trading strategyT& Cs, which rely on sophisticated mathematical models such as value at risk (VaR) and optimal f portfolios (OFP). Financial institutions use these strategies due to their ability to use historical data to create a statistically accurate model of how a market should behave in a particular market condition. These strategies require significant programming knowledge and time, so you will need assistance from someone who has this knowledge if you want to try them out. Some algorithmic strategies may require special licenses from the financial authorities, so do your research before testing them out. Automated trading strategies help Australian traders save time when forex and CFD trading can be achieved via algorithms.
Trading with algorithmic strategies is an excellent way to achieve the three key benefits of speed, accuracy and profitability. You can test these strategies on historical data using free software found online. Still, if you want to implement automated systems for live trading, you will need help from a professional who knows what they are doing.
Algorithmic trading has continued to improve over the years, and there are some clear benefits that it can help with your trading strategy.