How to Use Algorithmic Trading to Your Advantage
Next to driving racecars or working in an emergency room, there is perhaps no career more fast-paced and time-sensitive than forex trading. As a trader, your job is to deal with volatile markets, where prices can change in a fraction of a second. Thus, every little bit of time you save counts.
This is where algorithmic trading matters, because through it, traders can save large amounts of time. But what exactly is algorithmic trading? How does it work, and why should traders consider using it?
What is Algorithmic Trading?
Algorithmic trading, often referred to as algo trading, involves using computer programs to execute trades automatically based on pre-set instructions or trading algorithms.
This means that pretty much any factor you can come up with — price, timing, trading volume — can be taken into account by the algorithm, and can thereafter be executed without human intervention.
While this might seem like something only available to large financial institutions with the capital to fund fancy technology, algorithmic and automated trading are also available to individual traders who can readily benefit from this kind of technology.
How Does Algorithmic Trading Work?
As you probably figured out, you can’t do algorithmic trading without, well, a trading algorithm. What these trading algorithms do is that they take data, and, through mathematical calculations, analyze market conditions.
They assess what trading opportunities may come out of those conditions, and execute optimally-timed trades based on those opportunities. These automated Forex trading algorithms are then implemented with the use of trading bots.
To illustrate, the most simple example would be a trader who develops a trading algorithm that tells the trading bot to execute buy orders whenever a specific forex currency pair drops to a fixed price point, and then sell it when it reaches a target price.
Without the algorithm-based trading system, the trader might be influenced by their own emotions about when to buy or sell. But with the trading algorithm, they get to cut out the emotions and execute trade solely on logic and data on such platforms like MetaTrader 4 or 5.
Exploring Effective Algorithmic Trading Strategies
So now that you know what algorithmic trading is, and how it works, the question now becomes — how do you use algorithmic trading effectively? Let’s look at a few different trading strategies that take advantage of different market conditions:
Trend following
The algorithms in this strategy are designed to identify and follow market trends and execute trades which line up with those trends.
Mean reversion
This strategy assumes that fluctuations in prices are temporary, as prices will always revert back to their mean value over time. Thus, algorithms in this strategy often execute trades when prices deviate significantly from the average.
Arbitrage trading
These algorithms take a look at the price differences between different markets or instruments, and then execute simultaneous trades among those different markets or instruments in order to lock in trading profits.
News-based trading
Similar to trend following, but geared towards market news and not market trends, this strategy involves teaching an algorithm to react to significant market news and executing trades based on how the news might affect price movements.
Benefits of Algorithmic Trading in the Forex Market
So what exactly is the benefit of using algorithmic trading as opposed to just manually executing trades? Well, in the Forex market, using algorithms can offer numerous benefits that doing everything yourself just can’t bring. Here’s how it can work to your advantage:
Speed and Accuracy of Algorithmic Trading
Imagine having to do every single trade one by one all by yourself. Not only would you probably be stressed out of your mind, but it would simply take too long, and before you know it, so many other great trades probably passed you by.
Reducing Human Error in Trading
While machines aren’t always perfect, they are at least sure to make decisions based purely on data analysis and hard logic. The same can’t be said for us humans, where our feelings about things can often get in the way of proper decision-making.
In trading, this is what we call emotional trading, which can often result in significant losses. Things like trying to make up for a loss, or expecting price fluctuations based purely on “vibes” are clear examples of emotional trading, which trading algorithms don’t succumb to.
Another example of how trading algorithms help avoid human error is through the strategy of black-box trading, where the logic behind the trading strategy is hidden, thus allowing the trader to be assured that the trades are based purely on data and not on emotions.
Maintaining Trading Discipline and Eliminating Emotions
Traders, like any humans, can get bored, or impatient, or just plain sick of things sometimes. Often, these kinds of emotions can affect a trader’s trading discipline. Sometimes, traders will exit their strategy too soon, or change their trading parameters without really testing them first.
By automating the trading process, algorithmic trading ensures that traders stick to their predefined trading strategies and trading parameters. As a result, traders can stay consistent in their trading, and follow their strategies to fulfillment.
Building Your Own Algorithmic Trading System
Now that you know how and why to use algorithmic trading, what does building that kind of algorithmic system look like? Well, it requires a lot careful planning and a good understanding of both the forex market and technology. Let’s look at some of the key things you need to know in order to build your own algorithms:
Choosing the Right Trading Platform
The first step in setting up an algorithmic trading system is selecting the right algorithmic trading platforms. Luckily, most forex brokers provide systems that implement trading algorithms.
Platforms like MetaTrader4 are popular among traders for their robust features and ease of use. Regardless of which trading platform you choose, however, make sure to choose one that allows for customization, backtesting, and integration with trading bots.
Learning the Basics of Algorithmic Trading Programming
Now comes the fun part, actually building your trading algorithms! In order to do this, it might help to learn a little bit of programming, but only just the basics.
MQL4 is the typical language used to create custom algorithms within trading platforms like MetaTrader 4. It shouldn’t take too much time to figure out these languages, and once you do, you’ll be able to properly program your trading bots and set trading signals tailored to your automated trading needs.
Testing Your Algorithmic Trading Strategies
Once you have your trading algorithm down, don’t release it out into the wild just yet! Make sure to backtest your trading algorithm using historical data. Doing this will allow you to refine your trading strategies and ensure that they can adapt, regardless of market conditions.
Remember not to skip backtesting, as it’s a crucial step in risk management, enhancing trading efficiency, and having a smooth, hassle-free automated trading experience.
Conclusion
If you’re looking for a way to boost your forex trading efficiency and accuracy, algorithmic trading offers you a powerful solution. Through algorithmic trading, you can leverage the power of technology to automate the trading process. Algorithmic trading can be applied to many strategies, including trend following, mean reversion, and arbitrage trading.
Note that in order to achieve the best results with algorithmic trading, it helps to understand exactly how trading algorithms work, as well as to choose the right trading platform, and test your strategies. This way, you can gain an edge in the financial markets.
