Around three decades ago, the forex market was defined by trades executed over institutional investors, telephone, blurred price data, low market concentration, and a big difference between dealer to customer and dealer to dealer trading.
Technological advancements in some of the global hubs for financial markets such as the UK have revolutionized the foreign exchange market. Trades can now be executed fast through your computer which enables retail traders to access the market, while the streaming of actual time prices has maximized transparency.
Further, the difference between dealers and their most experienced customers has reduced. The introduction of algorithmic trading has also been a significant change in the industry, that has brought about enhancements to the practicality of foreign exchange trading.
However, algorithmic trading also comes with risks. This article will help you understand the basics of algorithmic trading and the forex market.
The Fundamentals of Foreign Exchange Markets
Currency pairs in the forex markets are traded in different volumes depending on the quoted prices. The price of a base currency is determined regarding a quote currency. Foreign exchange is among the biggest and most liquid market globally.
Trading runs 24 hours a day, five days a week. Further prices keep on fluctuating. However, investors can still succeed in low volatility environments. The global average forex trading volume per day two was estimated to be $ trillion in the year 2017. Much of this trading is executed in British pounds, US dollar, Japanese yen, and Euros.
It also involves various players such as corporations, financial organizations, pension funds, central and private banks, and individual retail trades. Foreign exchange markets exist because people want to constantly purchase foreign services and goods, and for this, they have to trade currencies. However, some investors are motivated by speculative trading.
Undertakings in the foreign exchange market can influence actual exchange rates which can have a huge impact on employment, output, capital flows and inflation in any country. This explains why the forex market attracts the attention of various players such as the media, the public, and policymakers.
Algorithmic Trading Basics
An algorithm is defined as a set of certain rules structured to complete an outlined task. In the financial trading, market computers execute user based algorithms distinguished by a set of regulations such as price, timing, or quantity which regulates trades. There are various fundamental algorithmic trading types in the financial markets as seen below.
This is an algorithmic approach that seeks for cost-effective trading opportunities depending on the analytical evaluation of historical time data.
· Algorithmic Execution
This approach aims at implementing a predetermined goal such as minimizing market influence or completing a task quickly.
This approach creates regulations to minimize a trader’s vulnerability to risk.
· Direct market access
This is the lowest costs and highest speeds at which algorithmic traders are capable of accessing and getting connected to different trading platforms.
· High-frequency Trading
This is an algorithmic trading subcategory that is defined by high trade order execution speed and rate. High-speed trading can provide traders with numerous advantages such as:
- High-frequency trading can give significant advantages to traders, including the ability to make trades within milliseconds of incremental price changes, but also carry certain risks when trading in a volatile forex market.
Algorithmic Trading in the Foreign Exchange Market
A huge percentage of the development in forex algorithmic trading in the last few years has been necessitated by the fact that algorithms can automate specific procedures hence cutting down the time required to execute foreign exchange transactions.
Automation generates an efficiency that results in lower operational costs such as execution of exchange-traded funds. Using an algorithm specially designed to trade according to a predefined basis to automate a trading process such as order execution over a particular price or period of time is more efficient as compared to manual execution.
Algorithmic trading has managed to cut down currency trading costs and enhanced efficiency. However, it comes with more risk. Currencies need to be more liquid and in solid value to operate adequately. This means that, volatility and liquidity of the forex market are highly necessary for its success.