The Way The World Moves Money is Constantly Changing
Today, technological advancements have transformed the forex market. Trades can be made quickly over your computer, allowing retail traders to enter the market, while real-time streaming prices have led to greater transparency , and the distinction between dealers and their most sophisticated customers has been minimized.
Another significant change is the introduction of algorithmic trading , which may have lead to improvements to the functioning of forex trading, but also poses risks. In this article, we'll identify some advantages algorithmic trading has brought to currency trading by looking at the basics of the forex market and algorithmic trading while also pointing out some of its inherent risks.
In forex markets, currency pairs are traded in varying volumes according to quoted prices. A base currency is given a price in terms of a quote currency. The bulk of this trading is conducted in U. Activity in the forex market affects real exchange rates and can therefore profoundly influence the output, employment, inflation and capital flows of any particular nation. For this reason, policymakers, the public and the media all have a vested interest in the forex market.
An algorithm is essentially a set of specific rules designed to complete a defined task. In financial market trading, computers carry out user-defined algorithms characterized by a set of rules such as timing, price or quantity that determine trades. There exist four basic types of algorithmic trading within financial markets:. One of the subcategories of algorithmic trading is high frequency trading, which is characterized by the extremely high rate and speed of trade order executions.
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. Much of the growth in algorithmic trading in forex markets over the past years has been due to algorithms automating certain processes and reducing the hours needed to conduct foreign exchange transactions.
The efficiency created by automation leads to lower costs in carrying out these processes , such as the execution of trade orders. Automating the trading process with an algorithm that trades based on predetermined criteria, such as executing orders over a specified period of time or at a specific price, is significantly more efficient than manual execution.
Banks have also taken advantage of algorithms that are programmed to update prices of currency pairs on electronic trading platforms. These algorithms increase the speed at which banks can quote market prices while simultaneously reducing the number of manual working hours it takes to quote prices.
Some banks program algorithms to reduce their risk exposure. This allows the bank to maintain a pre-specified level of risk exposure for holding that currency. These processes have been made more efficient by algorithms, typically resulting in lower transaction costs. Yet, these are not the only factors that have been driving the growth in forex algorithmic trading.
Algorithms have increasingly been used for speculative trading, as the combination of high frequency and the ability to quickly interpret data and execute orders has allowed traders to exploit arbitrage opportunities arising from small price deviations between currency pairs. Within the forex market, the primary methods of hedging trades are through spot contracts and currency options. Spot contracts are the purchase or sale of a foreign currency with immediate delivery. The forex spot market has grown significantly from the early s due to the influx of algorithmic platforms.
In particular, the rapid proliferation of information, as reflected in market prices, allows arbitrage opportunities to arise. Triangular arbitrage , as it is known in the forex market, is the process of converting one currency back into itself through multiple different currencies. Therefore, many currency speculators rely on the availability of enormous leverage to increase the value of potential movements.
In the retail forex market, leverage can be as much as Higher leverage can be extremely risky, but because of round-the-clock trading and deep liquidity , foreign exchange brokers have been able to make high leverage an industry standard in order to make the movements meaningful for currency traders. Extreme liquidity and the availability of high leverage have helped to spur the market's rapid growth and made it the ideal place for many traders.
Positions can be opened and closed within minutes or can be held for months. Currency prices are based on objective considerations of supply and demand and cannot be manipulated easily because the size of the market does not allow even the largest players, such as central banks, to move prices at will. The forex market provides plenty of opportunity for investors. However, in order to be successful, a currency trader has to understand the basics behind currency movements. The goal of this forex tutorial is to provide a foundation for investors or traders who are new to the foreign currency markets.
We'll cover the basics of exchange rates, the market's history and the key concepts you need to understand in order to be able to participate in this market. We'll also venture into how to start trading foreign currencies and the different types of strategies that can be employed.