The one thing the German people have always gotten right is their fine attention to detail and precision engineering. Like a finely tuned engine we start our journey with the intertwined bodies of Forex mathematics and surgical precision.
In the same way that a new Mercedes Benz devours corners, a systematic Forex robot will allow you to smoke profits all day long by removing human constraints, like a need to sleep, which takes the edge off having to drink so much Red Bull and therefore maximize your portfolio’s returns.
What is an algorithm?
An algorithm is a set of instructions that need to be followed in a step by step process to complete a task. Algorithms form part of our everyday life and more importantly when combined with a programming language they become a powerful tool in order to get a machine to complete tasks.
In terms of Forex trading, a user will program a trading strategy and then back test it to analyze the statistical validity of the system. It will then be tested using walk forward analysis and then once the Forex robot has been optimized a user will test it with real money.
Types of trading systems
In terms of trading there are 2 categories of systems, discretionary and systematic which are explained below:
A discretionary system is a method of Forex trading that relies on the experience and decision process of the portfolio manager. For example: a manager will look at several economic conditions and a few technical indicators and then use his discretion to place a trade that he/she believes will be profitable.
As the name suggests a systematic trading system follows an algorithm which is broken down into an alpha generating model and a risk model in order to place trades that the system has deemed to have a statistical edge / validity. For example: a simple alpha model like the moving average cross over strategy can be combined with a fixed fractional risk management model in order to generate profits in a trending market.
Who uses trading algorithms?
Trading algorithms are used by several Forex market participants.
To tell the truth, anyone can develop an algorithmic trading robot and implement it, but the problem lies in developing the necessary skill set. For starters you will have to learn how to program and have a firm grasp on mathematics, its developing these skills that thins the herd.
Some Forex traders simply don’t have the time to learn a programming language yet alone how to perform tests of statistical validity.
However, it would be wise to note that automated Forex trading is gaining more and more popularity with over 70% of trading volumes, in the American markets, being generated from trading algorithms.
A black box is a trading system or a portion of a system that the user has no inside knowledge, nor can he/she gain that knowledge. It is the part of a system that the developer doesn’t want to share with the outside world – adding a flare of intellectual property and secrecy.
Once the data has been processed the black box will generate buy or sell signals that the end user can use to achieve the set goal.
Note: this follows programming 101 which builds on the garbage in = garbage out rule. If the variables the user inputs in the first phase are garbage then the output will be exactly the same – garbage.
Types of algorithms used in trading:
1. Automated trading
By programming specific Forex trading strategies users can take advantage of a quick and emotionless expert adviser controlled environment. These strategies mainly range between: trending, relative value and mean reversion.
2. High frequency trading / low latency trading
These types of algorithms try to take advantage of price movement and discrepancies that are too fast for the human mind to react to. Their key focus is on the market micro structure.
Some institutions have different needs that are able to be fulfilled by the right algorithm. For example: some banks trade large positions – so large in fact that the order influences the price – an institution may require a trading algorithm that through a complex process of buying and selling small lots (breaking down the order size into a smaller size) is able to reduce the footprint left on the market such a large order.
We have taken the next step in evolution by giving birth to machines that sit behind the grinding stone and labor away for us. This is the process of implementing the logical decision making algorithms into computers that remove human error and emotions, like fear and greed.
This is where Forex robots, or expert advisors play a significant role in the market today. Whether or not you make the leap to take advantage of them is another story altogether.