By Frances Coppola
These days, ordinary people and small businesses can trade forex using widely available retail forex platforms. But monitoring the markets and obtaining information on which to base trading decisions requires expert knowledge and can be time-consuming. Automated trading enables people with little time or expertise to participate in the forex market.
All that is needed for automated forex trading is a computer, an Internet connection and an automated forex trading algorithm (also known as a “forex robot”). Standard algorithms with varying degrees of sophistication can be downloaded from the Internet, though experienced traders may prefer to develop their own algorithms using a standard scripting language such as MQL.1
Typically, automated trading algorithms (or “Expert Advisors”) mimic what an expert human trader would do. They examine technical forex charts and figures, and monitor news and market information, using them to decide what orders to place. But they go beyond simply giving advice. The algorithm itself determines the trading strategy and executes the trades.2 For this reason, automated forex trading is also known as “algorithmic trading.”
High-frequency trading (HFT) is a specialized form of algorithmic trading that executes trades at much higher speeds than can be achieved by human traders. High-frequency trading algorithms use their technological advantage to exploit small price discrepancies across different online trading platforms. The time to execute a high-frequency trade is measured in milliseconds – for comparison, it takes approximately 100 milliseconds to blink your eyes.3
The pricing discrepancies from which HFT aims to profit are fleeting. Even with today’s superfast communications, distance from price generators slightly delays receipt of price information, which can make all the difference between a profitable HFT trade and a loss. High-frequency traders therefore typically try to locate their computer servers as close as possible to the pricing engines of leading electronic trading platforms.4 So, HFT forex trading is not something that small businesses would generally consider.
In recent years, HFT algorithms have become important providers of liquidity to forex markets. However, they have been accused of causing “flash crashes,” where market prices suddenly drop for no apparent reason.5 Because they are designed to be sensitive to very small price changes, they can be overwhelmed when price volatility rises and may abruptly withdraw from the market. If a number of HFTs withdraw from the market simultaneously, sharply falling liquidity may cause the market to crash.
Today’s fast-moving interconnected forex markets are far more transparent than the telephone-based markets of the past. Single-dealer platforms use market data from the largest platforms when quoting prices: this data is updated in real-time and transmitted instantaneously around the forex market. Thus, all participants can see and respond to everyone else’s offers virtually as soon as they are made.
This helps to eliminate significant arbitrage opportunities, though HFTs can still exploit small timing differences between prices updating on different platforms. But it also means that a single large order can move the whole market.7
For big banks and financial institutions, this creates a problem. They typically trade large amounts. In a transparent or “lit” market, where everyone can see everyone else’s offers, the entire market can move against them between the offer and the trade, which can result in large losses. Thus, there is a growing tendency for large financial institutions to trade with each other privately. Platforms that enable financial institutions to trade privately without declaring market information are known as “dark pools.”7
People who participate in the forex market by means of automated trading may not know that their trades are being routed via dark pools. The problem with this is that in dark pools, prices are set by large participants rather than the market, so small traders may not get the best price.
Automated forex trading can enable individuals and small businesses to participate in the forex markets on equal terms with professional traders and financial institutions. However, specialist forex robots such as HFTs can cause markets to behave in unpredictable ways, while orders routed via “dark pools” may not be at the best price. People using automated forex trading systems may wish to keep a watchful eye on the decisions made by their forex robot.
With 17 years’ experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.
1. “How do automated Forex trading systems work?,” Admiral Markets; https://admiralmarkets.com/education/articles/automated-trading/how-do-automated-forex-trading-systems-work
3. “Forex market structure, players and evolution,” Norges Bank; https://www.unich.it/~vitale/Rime-2.pdf
5. “JPM explains how HFTs caused Friday’s sterling flash crash,” QuantMap; https://quantprint.webnode.fr/l/the-hft-liquidity-provider-paradox/
6. “FX dark pools predicted to rise,” Euromoney; https://www.euromoney.com/article/b12kjzw8js9ttq/fx-dark-pools-predicted-to-rise?copyrightInfo=true