Up until the 1970's foreign currency trading was conducted over the phone by primarily institutional investors. In what was a relatively closed market there was very little transparency in pricing information and a large gap between interdealer trading and dealer-customer trading.
When computer trading systems were first introduced into the American market in the late 1970’s the speed at which trades could be made began to increase, as did the level of transparency around factors and controls influencing pricing.
As technology began to advance rapidly so did the forex market’s ability to trade in real-time. By 2010 over 60% of all trades were being executed via computer, with an increasing focus on algorithmic trading.
How do forex algorithms work?
To understand how algorithms are used you first need a basic understanding of what they are. In its most simplistic definition, an algorithm is a set of directions and rules used to solve a problem. Algorithms usually incorporate complex formulas and mathematical models to calculate an outcome.
In the context of forex trading, an algorithm is a set of trading parameters that are programmed as instructions into a computer or platform to filter, analyse and execute foreign exchange trades.
These instructions take into account a range of variables including price, timing, lot size, risk parameters, stop-losses and take profit to find and execute trades on an exchange in real-time.
Every forex algorithm begins with a strategy created by a trader. The trader analysis the market and establishes a set of parameters that align with their chosen trading strategy to find an edge in the market.
These parameters are then programmed as algorithms and activated on an exchange. The algorithm then filters the market to find trades within these parameters. Once trades are found one of two things then happen:
Robotic forex trading: the trade will be made automatically by high-speed computers without trader input or oversight.
Signal-based forex generator: the algorithm will highlight and alert a trader who will then execute the trade. By using algorithmic trading, a firm or individual trader can execute tens of thousands of trades per second.
For algorithmic trading to be successful you first need to have a successful trading strategy. There are a few common algorithmic strategies that include:
- Autohedging: this strategy is designed to implement rules and parameters to reduce risk exposure for the trader.
- Algorithmic execution strategies: this method uses a predetermined outcome or objective to direct the trades executed.
- Statistical: in this strategy the algorithms analyse historical data to look for future profitable trade opportunities.
While there are both risk and reward to using algorithmic trading in forex major advancements in artificial intelligence is beginning to create highly sophisticated exchanges and technology to reduce risk.
The faster your algorithms and technology is, the higher the advantage you have over your competitors. Trading platforms and brokers with direct market access have access to the electronic market facilities used to make the final trade.
Individual investors typically do not have direct market access so when using algorithmic trading through a broker it’s essential to find a broker with direct market access, and the most advanced technology platforms and servers available.
USG’s award-winning platforms are great examples of market-leading technology enabling ultra-fast trading with optical-fibre connections to servers in New York and London.
To start your journey in Forex algorithmic trading open a free account with USG today and start learning how to trade and create winning algorithmic strategy.