What is 'Automated Forex Trading'

Automated forex trading is a system of trading foreign currencies with a computer program based on a set of analyses that help determine whether to buy or sell a currency pair at a given time. Automated forex trading uses a computer program that the trader “teaches” to make decisions based on a set of technical rules. The signal generates an actual buy or sell order that is executed.

BREAKING DOWN 'Automated Forex Trading'

Foreign exchange (forex) trading has become incredibly popular in recent years thanks to the ubiquity of online trading platforms and the 24-hour nature of the market. While many institutional investors rely on algorithmic trading, retail traders have only recently been able to harness the power of automated forex trading systems.

MetaTrader, TradeStation and other applications have made it easy to write simple computer programs based on technical analysis rules. Advanced traders may also create their own trading systems in programming languages like Python or R.

For example, a trader may write a program that places a buy order for a currency pair when the 50-day moving average crosses above the 200-day moving average and places a sell order when the pair moves 50 pips higher. Many forex brokers let traders automatically run these programs to execute trades.

Pros and Cons of Automated Forex Trading

There are pros and cons to using automated forex trading systems rather than placing trades by hand.

The biggest advantage of forex trading systems is that they take the emotion out of the process, which tends to reduce the behavioral finance biases that negatively impact investment decision making. Traders can also backtest trading system to see how they perform based on past data, which can help them fine-tune their strategies before using real capital. And, of course, traders don’t need to be present to generate profits from these systems.

The downside is that successful automated forex trading systems can be difficult to develop. While backtesting may show positive results, past performance is never a guarantee of future results and many trading systems are over optimized – or curve fit – for past results. Traders should exercise caution when buying “off the shelf” automated forex trading systems since they may be curve fit to the past and offer no or limited benefits for the future.

Using Automated Forex Trading Systems

Automated forex trading systems are a great way to get started in the world of quantitative finance. MetaTrader and other applications are free to use on demo accounts, which means that they can be a valuable way to practice building systems, backtesting them, and applying the concepts in practice by paper trading.

The best place to start is implementing techniques in a programmatic manner that you’re already using in live trading. For example, you may want breakouts from a prior reaction high, which is a concept that can be represented by scripting in languages like MQL. Traders may also use other platforms and scripting languages like TradeStation's EasyLanguage or programming languages like Python and R.

It’s important to practice trading before committing real capital and to keep an eye on automated systems to ensure that they’re performing correctly. [SEE: How to Practice Day Trading.]  In addition, traders should be sure to build in money management and risk tolerance strategies to limit downside in the event that unexpected price action occurs – such as whipsaws.

 

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