April 25, 2019, | AtoZ Markets - In simple terms, Algorithm + trading = algorithmic trading also quite often known as or mixed with automated trading strategies. But, what does that exactly mean? Here, in this article, we'll find out what is algorithmic trading, it's pros and cons and the best Forex algorithmic trading strategies.
These automated forex trading strategies are useful to those who are looking to eliminate or reduce human emotional interference in making trade decisions. After all, trading signals can be generated using a programmed set of instructions and can be executed right on your Forex broker's trading platform. However, in the end, it is your decision on how you can use algorithmic trading strategies for making forex trades in an effective way.
What is algorithmic trading?
Algorithmic trading is a system of trading which facilitates buy/sell decisions in the financial markets using advanced mathematical tools and strategies. In this type of a system, the need for a human trader is minimized and thus the decision-making process is very fast. This enables the automated trading system to take advantage of any profit-making opportunities arising in the FX market much before a human trader can even spot them.
As institutional investors deal with a large number of trade per day, they are the ones who make large use of algorithmic trading strategies. Before we list out the top 8 Forex algorithmic trading strategies, you should know the pros and cons of algorithmic trading before you implement it into your day-to-day life.
Pros and Cons of forex algo trading
- Minimizing emotions: these trading systems minimize emotions throughout the trading process.
- Backtesting: Backtesting applies trading rules to historical market data to determine the viability of the idea. When designing a system for algo trading, all rules need to be absolute without any interpretation.
- Preserving discipline: Because of trade rules are set and trade execution is performed automatically, discipline is preserved even in volatile markets.
- Achieving consistency: Allows traders to achieve consistency by trading the plan.
- Diversifying Trading: Permits the user to trade using multiple accounts or various strategies at one time.
- System failure: A trade order could reside on a computer, not a server, which means that if an internet connection is lost, an order might not be sent to the market. This could create the deviation between the theoretical trades generated by the strategy and the order entry platform component that turns them into real trades.
- Monitoring: It is possible for these automated trading systems to experience errors that could result in missing orders or duplicate orders due to the technical failures, such as connectivity issues, power losses or computer crashes.
Top 8 Forex algorithmic trading strategies
Many sophisticated trading algorithms aim to reduce emotional interference and disturbance into the trading process. Following trading algorithms help traders and brokers in executing orders and provide an optimal solution.
#1 Trend following trading strategies
Tracking and following market trends lie at the very heart of trend following trading strategies. Traders can set technical conditions appropriate for buy and sell orders. Also, there’s a possibility to take into account previous historical data and build future projections on this basis.
In cryptocurrency world you can find AEIEVE using such strategy, combined with their own AI system.
#2 Mean reversion trading strategies
Mean reversion trading strategy is an algorithmic Forex strategy based on the assumption that markets are ranging from 80% of the time. The terminals executing this strategy are usually calculating an average asset price based on historical data. Furthermore, they are placing trades in expectation of current price returns to the average price.
#3 News-based based trading strategy
Next, a news-based algorithmic trading system can be a good option for more adrenalin loving traders. In this strategy, a trading system is essentially connected to news wires. Actual data is compared to the market consensus or previous data. Afterward, depending on the results, trading signals are generated. This tradign strategy can bevery profitable but also involves a high risk possibility.
#4 Market sentiment based trading system
For the ones involved in market sentiment based trading strategy, the process is clear: a system observes a specific trading instrument and detects extreme net short and long positions. Either it can use The Commitments of Traders (COT) report for collecting the information. The latest approach also allows scanning of social media to find out the biases towards the particular currency.
#5 Arbitrage strategy
To make significant profits with arbitrage strategy, you will need to trade in large positions. Specifically, the strategy implies finding price imbalances in the market and making a benefit out of it. However, usually, the differences in prices are microscopic and quickly eliminated when discovered.
In addition, one popular strategy in this classification is triangular arbitrage. It involves two currency pairs and a currency cross between two of them.
Cryptocurrency exchanges used to have big arbitrage opportunities in 2017. Thus you could see people open Binance account and Huobbi account and a few other accounts, mostly in Korea and look for price differences.
#6 High-frequency trading strategies
High-frequency trading is often mixed in retail Forex world with scalping. However, in reality HFQ includes scalping but is not limited to it.
In this case, high trade volumes and quick price fluctuations are the best characteristics of the strategy. The trades are closed in milliseconds, and the system itself is operating at a speed of light. These strategies typically used here are arbitrage and scalping and essentially involve quick fluctuations in price and high volumes of trade.
Japanese and Korean traders are specifically focus on high frequency trading. In fact, cryptocurrency exchange Huobbi conducts conferences dedicated to HFQ in different parts of the world.
#7 Iceberging trading system
Large financial institutions prefer to retain secrecy about their positions on Forex. That is the reason why they are not placing their orders to only one broker, but instead, divide it into smaller positions and execute these under different brokers.
This scheme allows them to place smaller orders at different times, which prevents other market participants from finding out. Financial institutions can trade under normal market conditions this way, avoiding sudden price fluctuations. What other traders see is usually only “the tip of the iceberg”, but not the whole picture itself.
Very much related to the previous strategy, stealth is the one not tolerating a mystery behind “iceberg”. The algorithm was designed to assemble the pieces of orders. This way, market watchers will find out whether a large player is hiding in the back.
Algo trading is a numbers-based approach to filtering trades that helps traders to approach trading in a calculated way, which can eliminate risks and increases the risk-to-reward ratio. Not only is it time-saving, but it takes out a lot of human errors and helps traders to locate strong potential signals for forex trade.
In our modern world, AI systems are being combined with algo trading strategies. We can expect to see this sphere thrive and grow as we see AI based trading systems grow.
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