World Commerce Review
December 2007
By: Marilyn McDonald
Any trader who is even remotely familiar with retail foreign exchange knows what an extremely volatile market it is. This year alone international currencies have fluctuated wildly, with the dollar reaching decade, and in some cases even all-time, lows. Within the forex market realm, however, volatility often creates opportunity. And because forex is open for trading 24 hours a day, five-and-a-half days a week, it is nearly impossible for any one trader to take full advantage of every opportunity that arises during market hours. As a consequence of this growing desire to trade around the clock, automated trading has piqued market-wide interest and completely changed the face of forex trading.
Automated trading, or algorithmic trading is using computer programs to generate nearly instantaneous buy and sell orders. This type of trading has been leveraged heavily by institutional traders and is now gaining popularity in the retail sector, particularly in the forex market. Algorithmic trading accounts for a third of all share trades in America and the Aite Group, a Boston-based consultancy group, thinks it will make up more than half the share volumes and a fifth of options trades by 2010.
There is little doubt that in recent years automated FX trading has exponentially increased in both corporate and retail arbitrage strategies throughout the world. And as demand for better execution performance and reduced latency continues to grow, automated trading becomes increasingly more embedded as a key tool for the successful forex trader.
Whether you are active in the FX arena or new to this dynamic sector, you will most certainly have come across the three following idioms: Don’t allow greed and fear to cloud your trades; always set a stop loss and profit objective; and execute trades quickly. Using an automated trading system fills each of these requirements and has the added benefit of being able to trade around the clock in this 24-hour-a-day market.
When considering an automated trading system, it is essential to bear all of these in mind. Take the time to think through your system carefully. Considering all of the possible outcomes is key to the best possible system. Keep in mind that your system won’t make adjustments for market volatility, nor will it take every eventuality into consideration unless you have already thought through every conceivable scenario and made the appropriate modifications. What’s more, a well thought out system will not modify a stop loss because it believes the market will rebound, nor will it modify the profit target of a trade because it suddenly thinks it can make more money. The program won’t second guess itself and the execution is performed within seconds — it sees a signal and it places the trade.
If you have been in the forex game for any length of time, you have most certainly spent countless restless nights worrying about that one trade that will either bring you riches or flatline your account. An automated system eliminates the problem of emotional overload and gives you peace of mind knowing that your program can identify trading opportunities, set trailing stops, and profit targets. No more late nights spent worrying about your trades.
Which brings up yet another advantage of automated trading — your ability to trade while away from your desk. An effective strategy could trigger a myriad of signals and create profit during times at which you have previously been unable to trade. The average “nine-to-fiver” is no longer limited by time constraints.
Greater diversification is yet another fascinating aspect of employing a computer in your trading. Automated trading now allows one single trader the ability to trade in different markets and different time zones simultaneously. A system can be programmed to analyze short-term data and scan for opportunities on any and all available currency pairs and periodicities, essentially eliminating the need to open 15 charts to ensure you don’t miss out on a good trade. An effective program can make certain that you see any available opportunity and execute the trades accordingly.
So the question that begs to be answered is how does one develop an effective automated trading strategy? Well, you need to consider the issue from three different perspectives; as a trader, as a programmer, and as a technology specialist.
As the trader you must be able to clearly specify your trading behavior across all of your chosen currency pairs, in all different market conditions, and in all applicable time frames. This is what I consider to be the major stumbling block for retail level forex traders that are becoming interested in automated trading. It is one thing to look at your charts with all of your indicators and make trading decisions. It is quite another to write down the rules of your systems and only trade by those rules. You may be making considerations that you can’t even pin point. You can’t program a system to look at generalities, you must make specific rules that you never violate. A good start is to keep a notebook next to your trading platform and record exactly why you buy and sell. This is an important part of the process that many gloss over and then wonder why their system doesn’t perform as they think it should.
The technology specialist in you has already selected a trading platform. However prior to building your system it is not a bad idea to look around at all the offering and make sure that you using the best technology for your objectives. There exists today a myriad of popular platforms — including several that are free of charge — provided by a number of forex brokers for development and back testing. Consequently, it is now possible for the retail investor to start trading on a variety of platforms that were once available only to large financial institutions.
Once you can clearly identify your trading behaviour you can begin the programming process. This can either be done by the trader or done as work for hire. There is an entire cottage industry that has sprung up around automated trading for the retail trader. Make sure that your system is clearly defined before starting the programming process. Without this foundation, the project will only end in tears. If you choose to program your own system it is wise to look for a broker or platform that offers a full function library of basic systems.
Automated trading for the retail forex trader is really in its infancy and while this segment of the market is poised to grow substantially over the next few years only the prepared will be able to take full advantage of the full offering. If this happens to be an area that you are interested in I would suggest taking full advantage of all of the information available on this subject, perhaps even studying the algorithmic trading systems of other securities industries. This will give you the greatest insight into what needs to be considered when creating your own strategies.