What is Algorithmic Trading

Robots are dominating Forex trading and the algorithmic trading industry developed extraordinarily. To put this in perspective, imagine that almost 30% of the London’s trading is now made by robots. Sudden spikes and dips that are seen in the market when an important news is released. These moves are caused by robots trading in the same direction, at the same moment of time. It is not possible for human traders to do that. But robots can execute thousands of trades per second, in complicated algorithms based on quant math. Therefore, human traders are following robots. It is well-known that ahead of important economic events, no matter your analysis, if the news in interpreted as bullish by the robots, the price will jump. Like any market, the Forex market is subject to supply and demand imbalances, and these are mostly seen during important events. Algorithmic trading is being spotted when important events are released, like Non-Farm Payrolls, the FOMC (Federal Open Market Committee) Statement, ECB press conferences, and so on. Because of the huge volume that is traded on the Forex market daily, these sudden spikes and increase in volatility are largely attributed to robots, and not human traders. However, these robots are programmed by humans, so, in a way, human nature is incorporated, and the error factor is still there.

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Why Using Algorithmic Trading

One reason for using algorithmic trading is to take all the trading signals that a trading strategy can offer. As a human trader, one cannot trade 24/5, all the time the Forex market is open. Therefore, a strategy can be coded, programmed. Not all of them can be coded, but the ones based on technical indicators, like oscillators and all, can. Such a robot is instructed to buy or sell when specific conditions are met. If the indicators or the inputs are giving a signal, the robot will take it. Be careful before stating that a strategy works: back-test it both manually and automatically. Moreover, the results may still be different. This is due to slippage that can appear. Even more, results in a demo account will be different than the ones in a live account because the execution is different. As an example, imagine an ECN (Electronic Communication Network) broker. Such a broker has tight spreads most of the times in a trading day, except for periods when volatility is high and when positions are rolled over on the next trading day. If there is a trade to be taken during these times, slippage and the costs associated with the trade (spreads) will result in an additional cost. These costs are not being seen when backtesting a strategy. Nevertheless, retail traders that are not able to watch market and are not doing this for a living, prefer to trade with robots. It has advantages and disadvantages, and traders will answer differently to such a question. The ones that oppose algorithmic trading will say that there is no robot that can see what the human eye can see. Those that favor this trading type, will say that emotions are left aside and greed and fear will not intervene in trading anymore. Fear and greed are the biggest enemies in trading and mistakes caused by them are avoided with algorithmic trading. But this doesn’t make trading perfect, though. Another reason why algorithmic trading is used by big investment houses is that in this market, the one that is the first to execute the trade will have a bigger chunk of the profit. There is an ongoing race between investment houses for the best technology to be used as this would offer a giant competitive advantage But, competition is so stiff in this area, that it is difficult to be the first one. Even fractions of a second are making a difference between successful or losing trades.

Algorithmic trading is also called high-frequency trading.

This is because of the huge number of trades that is taken by these robots in a very short period of time. These robots are programmed to buy or sell based on the economic news that is released. If the actual news differs from the expected data, the trading algorithms are programmed to buy or sell a currency/currency pair. The bigger the difference, the bigger the resulted move. Also, trading algorithms are buying and selling a currency based on snippets in a news, looking for words that may signal a change in the monetary policy of a central bank. If the central bankers are using hawkish words in their statements, the algorithms will buy that currency. On the other hand, if the message is perceived as dovish, the trading algorithms will sell a currency. All in all, if you’re looking for someone to blame for the sudden spikes when economic news is released, you have found the usual suspect. Such news where algorithmic trading can be spotted are:
– The Non-Farm Payrolls in the United States;
– The European Central Bank’s interest rate decision;
– The FOMC Statement;
– Other major central banks interest rate decisions and press conferences;
– Any speech held by major central banks, etc.
What is Algorithmic Trading
To sum up, look for red events in the economic calendar to have trading algorithms spotting for the probable move. Human traders should avoid reacting to this news and, instead, should focus on the bigger picture. Trading bigger timeframes are the way to go, as this would filter the daily noise and fake moves caused by algorithmic trading. Moving forward, expect the trend to become even more aggressive. New MiFID II regulation is about to be introduced in the United Kingdom starting in January 2018 due to Brexit. While this is affecting mainly UK brokers, it has ramifications in other jurisdictions, as well as UK traders, are not bound to trade only in the UK. One of the changes refer to slippage and execution, so algorithmic trading, at least on the retail side, will change once again. Most likely, in time, other jurisdictions will move in the same direction, again changing the way markets are traded.

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