FOREX ALGORITHMIC TRADING BASICS
When the Forex currency market began to form, transactions were made by telephone between institutional investors and dealers. Trade volumes were small, and pricing information difficult to access. Modern technological advances have radically changed the market. All trade is now conducted through computer networks, and dealers serve private clients in real-time. Streaming prices allow you to see the situation on the market at any time, and forex brokers provide access to trade for everyone. An important phenomenon was the automation of the trading process. Computer programs can perform a certain sequence of actions on the market without human intervention.
ALGORITHMS IN MARKET TRADING
An algorithm is a sequence of actions recorded in the form of precise commands that are understandable to the performer and aimed at obtaining a result from the source data. In today’s world, all currency exchange operations are performed by computers using human-driven programs. That is, the operator sets the quantity, time and price of the application, and then the programs do everything themselves, interacting with each other. With the expansion of the international foreign exchange market and an increase in the number of transactions, algorithmic programs began to be introduced to replace the operator’s manual labor.
For example, banks use algorithms to update quotes of currency pairs on trading floors. Algorithms significantly increase the speed of determining changes in market prices. Algorithmic programs are widely used by market makers to supply liquidity to the market. Algorithms even caused a change in market microstructure. Exclusively electronic execution of exchange operations was formed in the nineties of the last century when the decimal system necessary for algorithmic trading was introduced. As a result, the advantages of market makers have decreased, and market liquidity has increased.
In the process of automating market processes, new trading algorithms appeared that took into account prices simultaneously on many exchanges. Computers have completely replaced human data processing activities. The large-scale electronic trading has reduced commission fees, contributed to the merger of brokerage companies and the unification of financial markets. The Forex fundamentals market that we see now is the result of computerization and the development of trading algorithms.
Exchanges constantly compete in the fight for the highest speed of order execution. Back in 2007, the TradElect system was launched on the London Stock Exchange with the execution of orders in 10 milliseconds and the processing of 3 thousand orders per second. Gradually a speed of 3 milliseconds was achieved, and today it is not uncommon to execute orders in one millisecond. Such qualitative changes made algorithmic trading possible for institutional and private traders. About 50% of exchange trading is conducted by algorithms. The same trend has spread to the Forex market, where about 20% of orders are generated and executed by algorithmic programs.
TYPES OF ALGORITHMIC TRADING
Any investment strategy of large traders can use algorithmic trading. Partial support, as well as full automation of the process, are possible. Algorithmic trading is mainly used by large market participants, such as mutual and pension funds, hedge funds, investment financial institutions. For the most part, the algorithm for crushing large applications is used. Institutional traders operate in large volumes, which is fraught with the risk of losses. Too large an order volume may not find a counterparty and favorable price, and will also affect the market.
Previously, the operation of crushing applications was carried out manually, even there were companies that performed this work (execution services). At the beginning of XXI, algorithmic engines were created that performed the same actions that traders did. The trader sends a request to the “engine”, selects an algorithm and controls the execution. Initially, algorithmic “engines” were developed and used only by leading brokers, about whom we write articles. As they improved and spread, large private clients gained access to algorithmic trading. Brokers call their engines in different ways, for example, Forex broker Forex4you – calls it Share Algo, but according to the principle of action they can be divided into three main types.
The first, simplest one, is to divide a large application into equal parts and evenly send orders to the market at the current price. This algorithm is denoted by the English name TWAP. The work of this program is clearly visible in the order book, so its settings are often changed. The second algorithm, with the English name VWAP, in addition to splitting bids, takes into account trading volumes during the day. And the third algorithm, called IceBerg, places small bids one at a time. That is, the entire sum of a large order is not visible to market participants.
Trading algorithms are mainly used to reduce the impact on the market and accelerate the execution of orders. But there are those that are used to make a profit. The idea of ultrafast trading on exchanges began to be implemented in 1998, and in 2009, high-frequency algorithmic trading was called “HFT” – High-Frequency Trading. Soon, these technologies spread to the Forex market.
High-frequency trading has been made possible through the use of powerful equipment, fast communication systems, combined with advanced software and special trading strategies. purchase and sale transactions are completed in a split second. Algorithms analyze data, look for trading opportunities within the minimum price movement. Tens of thousands of trading operations per day.
For a regular trader, high-frequency trading is not available. This is done by investment funds, banks, financial companies. HFT operations are capturing an increasingly large part of the market. In fact, the game is ahead of the curve, the one who earns faster algorithms earns more. Regulators have tried to prove the illegal nature of HFT profits, but have not found formal reasons. In fact, HFT traders have an advantage over the rest of the market.