Talk of trading algorithms that can be used by ordinary individuals has intensified in the past few years. But it’s worth noting that it’s no longer just talk. As our post ‘Algos Advance on FX’ noted, “many FX market participants” have taken the leap “into the algo pool,” causing a fairly sharp rise in overall adoption. In other words, more ordinary individuals (as opposed to large companies and massive fund operators) are beginning to make use of trading algos in forex.
This is generally easy to view as a good thing. In the most basic sense, we understand algorithms to be more capable than humans of navigating complex trading markets. By extension, it’s easy to expect them to produce more profits. But every now and then it’s worth stepping back for a moment and considering why people are opting for this route, beyond a vague notion of greater profitability. So — why should you consider using an FX trading algo?
The first and perhaps most important answer is that it’s a matter of competition. Early in 2020, Traders Magazine did a fairly through write-up covering various aspects of trading algorithms. In the article, it was pointed out that “due to the speed and precision” required in modern markets, they are “dominated by sophisticated automated algorithms with powerful resources behind them.” This is a way of saying that these algorithms are out there, and that powerful players in the markets are using them to “dominate.” It is becoming more and more true that individual human traders simply can’t keep up with the pace at which these algorithms make profitable trades — meaning the best way, and perhaps the only way to compete is by using an algorithm yourself.
Another factor specific to the FX market is that with an algorithm you can take advantage of unique trading hours. In a broad overview of forex trading basics by FXCM, it actually counts the “24/5” market conditions among the main reasons that people look into forex to begin with. As this overview says, “with no set exchange hours, you can trade currencies 24 hours a day, 5 days a week.” This allows plenty of humans to take advantage of odd hours, or to treat forex as an extra, after-hours side job. But of course, no human trader can actually manage the market “24/5.” An algorithm can. It can also be deployed specifically to trade currencies that may be more active when you tend to be asleep, or perhaps at work. Basically, an algorithm is your only chance to really take advantage of FX hours.
Managing liquidity and volatility also comes into play in this discussion. By nature, the FX market is both highly liquid and highly volatile. These are some of the things that draw a lot of traders to the market in the first place, because both make it possible to quickly execute profitable trades over the course of any given day. However, to speak once again to what algorithms can do that human traders cannot, taking full advantage of liquidity and volatility requires speed and attentiveness. An active, day-trading FX investor can certainly take advantage of these aspects of the market — and to be sure, millions do just that every single day. But an algorithm can do it faster and more effortlessly, allowing you to profit on hour-to-hour volatility without having to become a full-time trader.
Finally, there is also risk management to consider. In a back-to-basics explainer on the very concept of automated trading, Data Driven Investor got into some of the downsides of algorithmic trading as well. And one point they made was that just as an algorithm can rack up quick gains, “if the system starts to enter into losing positions, it’ll do so very quickly.” In other words, it’s possible for an algorithm getting it wrong to start losing you money more rapidly than you might lose it yourself with poor trading. The key difference, however, is that you can build in risk management when programming an algorithm. “A trading system can only do what you tell it to do,” as the article goes on to say. This means that you can set barriers in place, such that losing positions are abandoned before the losses mount up significantly. These kinds of protections can frankly be harder to enforce upon yourself as a human trader.
These are some of the specific factors and reasons that make algorithmic trading worthwhile. Far too often, it’s merely assumed that people should adopt this sort of method because it sounds more advanced, more intelligent, and more likely to be profitable. Even if those things are true though, it can be helpful to understand the more specific perks of algo-based FX trading